CHRG-111shrg52966--22 Mr. Cole," I would indeed, and thank you for the opportunity, Senator. First of all, I would say that my understanding is that the report that the GAO has done is really based on review of one institution. Senator Bunning. That is incorrect, but that is fine. " Mr. Cole," OK, and that we received this report with reference to perspectives on risk just in the last couple days. So we would like an opportunity to go over these findings with the GAO, as we typically do in GAO reviews. We have not had that opportunity. But I will say this, that I think that what Ms. Williams quoted from is in the report, but unfortunately, there are other parts that were not quoted, and one in particular is, quote: The effects of a long period of easy liquidity and benign credit conditions have continued to weaken underwriting standards across all major credit portfolios. Finally, we note that investor demands appear to be encouraging large financial institutions to originate more assets and even greater volumes of low-quality assets, and in order to distribute them through the capital markets.In response to that, we took very firm actions, and that---- Senator Bunning. When? " FOMC20060328meeting--131 129,CHAIRMAN BERNANKE.," Thank you. A number of people have talked about tightening monetary conditions. President Yellen did. Of course, long-term rates have not risen, so I guess there is a question here about the issue of how much is the term premium, how much is the change in the equilibrium rate. I just put that question on the table because your views on it should affect whether you think conditions are essentially easy or tightening. First Vice President Stone." CHRG-111hhrg58044--329 Chairman Gutierrez," Excuse me. One of your members is Experian, one of the big three credit bureaus. And it touts ``employment insight'' reports as providing insight into ``an applicant's integrity and responsibility towards his or her financial obligation.'' An applicant's integrity. It's easy to see a potential employer rejecting an applicant with negative credit information in his or her credit report, particularly when it is sold as providing insight into an applicant's integrity. So-- " CHRG-111hhrg58044--242 Mr. Green," I am not there yet. I am talking about the likelihood of having an accident, which I thought was going to be the easy question, by the way. Let me ask again: Will a credit score predict whether a person will have an accident? " CHRG-111shrg56415--5 Mr. Tarullo," Thank you, Mr. Chairman, Senator Crapo, members of the Subcommittee. Let me begin by echoing a few points that my colleagues made in either their written or oral statements. First, compared to the situation of 8 to 12 months ago, the financial system has been significantly stabilized. The largest banking institutions, each of whose financial conditions was evaluated in our stress tests and then announced to markets and the public, have raised $60 billion in capital since last spring. We continue to see a narrowing of spreads in some parts of the market, such as corporate bonds, and in short-term funding markets. Second, however, important segments of our credit system are still not functioning effectively. Many securitization markets have had trouble restarting without Government involvement. Lending by commercial banks has declined through much of 2009. This decline reflects both weaker demand and tighter supply conditions, with particularly severe consequences for small and medium-sized businesses, which are much more dependent on banks than on the public capital markets that can be accessed by larger corporations. Banks will continue to suffer significant losses in coming quarters as residential mortgage markets continue to adjust. Losses on CRE loans, which represent a disproportionate share of the assets of some small and medium-sized banks, are likely to climb. The strains on these banks, when added to the more cautious underwriting typical of recessions, compound the problems of small businesses that rely on community banks for their borrowing. Third, it is important that bank supervisors take an even-handed approach in examining banks during these stressful times. We certainly do not want examiners to exacerbate the problems of declining CRE prices and restricted availability of credit by reflexively criticizing loans solely because, for example, the underlying collateral has declined in value. At the same time, we do not want supervisory forbearance that will put off inevitable losses, which may well increase over time, with attendant implications for the Federal Deposit Insurance Fund. So it is relatively easy to summarize the situation and state the problem. The question on everyone's mind is when and how it can be ameliorated. There are no easy answers, but let me offer a few observations. We as banking regulators should certainly redouble our efforts to ensure that the even-handed guidance we are issuing in Washington will be implemented faithfully by our examiners throughout the country. But we should not fool ourselves that even the best implementation of this policy will come close to solving the problems caused by significantly reduced demand for commercial properties that were in many cases highly leveraged on the assumption of rising asset prices. The problems lie deeper. In a weak economy that has, in turn, weakened many of our banks, supervisory guidance is neither appropriate for, nor effective as, an economic stimulus measure. At the most basic level, the strengthening of CRE markets and a return to a fully healthy banking system depend on growth in the economy as a whole, and particularly on a reduction in unemployment. I believe that the most important Federal Reserve action to promote CRE recovery is through our monetary policy. Our actions to date have helped return the Nation to growth sooner than many have expected. Nonetheless, because economic performance remains relatively weak, the Federal Open Market Committee indicated after our last meeting that conditions are likely to warrant exceptionally low levels of the Federal funds rate for an extended period. The Federal Reserve has also taken a series of steps to increase liquidity for financing capital of interest to consumers and small businesses, including the TALF program, which we recently extended through March, with a longer extension for commercial mortgage-backed securities. I suspect, though, that more direct efforts may be needed to make credit available to some creditworthy small businesses. Congress and the Administration may wish to consider temporary targeted programs while conditions in the banking industry normalize. Thank you very much, Mr. Chairman. Senator Johnson. Thank you. Ms. Matz. STATEMENT OF DEBORAH MATZ, CHAIRMAN, NATIONAL CREDIT UNION CHRG-111hhrg52406--55 Mr. Bachus," Oh, okay. Ms. Warren. What I have suggested is an agency that offers plain vanilla products that provide a safe harbor on regulation. That is, if you will use an off-the-shelf, page-and-a-half credit card agreement or a one-page mortgage agreement, then you have met all regulatory obligations at that point, making it cheap for you and easy for the consumer to understand. " FOMC20070807meeting--172 170,MR. KOHN.," Yes, I do. I see why you want to take out “volatile,” and I agree with that. Unlike President Lacker, I think it is important to keep credit conditions in there because it’s more than just price. So I was a little concerned that saying “risk premiums have increased and credit conditions have become tighter” puts it all on price. Suppose we didn’t have the phrase in red. We just had “owing to developments in financial markets, credit conditions have become tighter,” or “reflecting recent developments in financial markets, credit conditions have become tighter.”" CHRG-111hhrg54873--125 Mr. Manzullo," Okay. Let me ask this question. Perhaps it goes to the heart of the collapse. Many of us find it incomprehensible that, in the rating of these mortgage-backed securities, the people doing the rating simply failed to realize that mortgages that were given to people who could not make the first payment were somehow tainted and could end up poisoning the whole. We are just--I don't know it got missed. When Members of this Congress were saying that credit was too easy and other groups said, no, it is not; and then everything went along--yes, sir. " CHRG-110shrg38109--135 Chairman Bernanke," There is no specific level of employment or unemployment that is a trigger, in some sense, for inflation. The main concern is to make sure that the overall spending in the economy, which is driven in turn by financial conditions, does not exceed the underlying productive capacity for a sustained period. That seems to generate inflation. But as I have mentioned a couple of times, it is not easy to determine exactly where that balance should be struck. And simply looking at the unemployment rate, for example, is not going to tell you. You need to look at a wide variety of indicators, including price indicators, to get a sense of when the economy is overheating and when it is more or less in balance. Senator Tester. That is great. And that is actually what I was hoping to hear. So we should be continuing to strive to make employment complete, full to the best of our ability? " CHRG-111hhrg51698--610 Mr. Kaswell," It is not easy. " CHRG-110shrg50418--97 Mr. Mulally," Yes, Mr. Chairman. I would--I think it is a really good point. I would just add in our case, we were just looking at the data, that I would say we didn't offer easy credit because we always had relatively high FICO scores. But to your point, the relative interest rate was relatively low to the consumer. You combine that with the low fuel prices and I think that, along with the lifestyle, that did incentivize a lot of borrowing. It kind of goes back to the issue we all have of kind of living beyond our means, and with a lower savings rate, it just continued to decline. But as far as fueling that with low credit scores, we have not done that. It has been a good business for us, a good prudent business with our finance company. " CHRG-111shrg54589--113 Mr. Pickel," Senator, yes. In the credit default swap area, we have introduced a very high degree of standardization, to I think your first point about which of these contracts would be most standardized. And I think that in the credit default swaps base, we do have contracts that will be very easy to move into a cleared environment, perhaps more so into an electronically traded or even exchange-traded environment. So those things are in place. And yes, I mean, people look to the Bloomberg screens, but it is the collective view of the marketplace, I mean, that arrives on Wall Street. We have got very active dealers around the world who are expressing views on these contracts and it is that collective reflection of the market judgment that indicates the spread at any particular point in time. " CHRG-110shrg50414--256 Secretary Paulson," I hear your comment that we need to work through this. We put this together. It was bare bones. But again, I will just say to you, this is not a position I wanted to be in. I didn't want to be in this position. I am the Treasury Secretary. We moved very quickly to deal with something and it is very easy to second-guess it and it is very easy for everyone to--everyone has got to do their job here. " CHRG-111hhrg56766--186 Mr. Bernanke," That is not an easy question to answer. " FOMC20050322meeting--193 191,CHAIRMAN GREENSPAN.," Yes, that’s easy enough. [Laughter]" FOMC20070628meeting--159 157,MS. MINEHAN.," Not always easy, I might add. [Laughter]" CHRG-111hhrg48868--453 Mr. Ackerman," No, it's easy. You don't have to be evasive. It's really yes or no. " CHRG-111shrg57923--39 Mr. Mendelowitz," Yes, Senator. This discussion about the housing bubble, I think, gives us an insight into what the need for the NIF is. While Steve said back in 2007 he saw it, those of you--but basically 5 years ago, I started predicting a major credit event in the housing sector that was going to push the economy into the worst recession since the Second World War, and it was really just based upon looking at relatively small data sets that went to what was happening to housing prices, what was happening to household income, and what was happening on the delinquency and default rate on mortgages, all of which was readily available data. So it was easy to predict a major credit event in housing and it was easy to predict, because of the widespread nature of home ownership, that this was going to lead to a recession that was going to be driven by falling consumption. That was the easy piece of it. Now we are saying the fact the Fed didn't see it, because they were using the standard monetarist model, and if you can't see something with the monetarist model, you don't see it. But what I didn't see and couldn't see and couldn't understand was how what was happening in the housing sector was going to lead to the collapse in the financial sector. And it is the kind of data that we are talking about the NIF collecting that would provide that insight, and there is no substitute for that. There is no alternative. There is no shortcut. Because at the end of the day, you have to know where the concentrations of risks are and you have to know what the nature of the intertwined network of financial firms and their obligations are, because it is the combination of concentrations of risk and the exposure of the network that can produce a domino effect of multiple failures that creates a systemic risk. And so it is one thing to see a macroeconomic crisis tied to something like housing. It is something entirely different--the data needs are entirely different when it comes to understanding the systemic risk that flows from those concentrations of risk. Senator Reed. I want to thank you all for excellent testimony, thought provoking, and also for your advancing this issue. I think we leave here with, one, we need better data. We need better analysis. And if we don't achieve it in the next several months, the bubbles that might be out there percolating, if that is the right term, will once again catch us by surprise and we shouldn't let that happen. But thank you all very, very much. Thank you. " FinancialCrisisInquiry--539 MAYO: How you define that is not always easy. I feel like we’ve overdone it, though. CHRG-111hhrg48875--140 Secretary Geithner," Because it's easy with hindsight to go back and say that if only ``X,'' then ``Y.'' " FOMC20060510meeting--210 208,MS. MINEHAN., There are easy ways to modify row 4 to make it do the same thing. FOMC20060510meeting--11 9,MR. HILTON.," No, I think that adapting to that environment would not be a problem for us. It would probably be very easy to do." CHRG-111hhrg54868--105 Mr. Hensarling," I thank you. Clearly, I didn't hear it was inaccurate, but I respect that you wish to keep it confidential. I understand that. But I do think it is important that this committee hear your commitment to independence. Your opinion, and I have disagreed with your opinions on many occasions, and I assume that on future occasions, I will disagree again. But it is a terribly important opinion. It is a terribly relevant opinion. And this committee needs to know it is an independent opinion. And I am not quite sure how one proves a negative, but with articles like this, you can understand a number of us on the committee remain concerned. Perhaps this will be a bit simpler question to answer. The CFPA, as presently constituted in the Administration's White Paper and in Chairman Frank's bill--and I know we have this memo floating around ostensibly from Chairman Frank to members of his committee. I haven't heard the chairman either verify or deny the accuracy of that memo. So, theoretically, the bill may change. But again, I don't know the accuracy of this memo. My question is this: The CFPA as presently constituted, in your professional opinion, could it or would it lead to less credit and more costly credit for families and small businesses in our economy? Again, I suppose going left to right to make it easy, Chairman Bair? Apparently, it wasn't that easy of a question. Ms. Bair. With so many of these issues, it depends on who is the head of the agency and how it is structured, and I think that the structure is in flux: Chairman Frank's observation about placing the focus prohibiting bad practices as opposed to identifying and enforcing good practices may help address that concern. " FOMC20070807meeting--136 134,MR. KROSZNER.," Thank you very much. I also support keeping the fed funds rate unchanged, and I very much agree with the way that Governor Kohn was thinking about what we’re trying to achieve. So let me just describe why I think that alternative B as is largely achieves that. The key to my thinking about the decision on changing the statement is, first, whether something has materially changed so that the markets will realize that, when we change the statement, we do so because something has actually happened and, second, whether it gives us the flexibility going forward to make another change if new information comes in. So, for example, in paragraph 2, acknowledging the volatility and talking about credit conditions, about the housing market, and then about the offsetting factors of employment, growth in income, and global demand—all those things are relevant. The new things—the financial markets and credit conditions—have been there a bit but are now more important than they were before. So we’re acknowledging things that actually have happened in the intermeeting period. I also like that it gives a bit more color about what’s going on and how we’re thinking about things, and each piece is one that we can easily leave, add to, or take back, and that is very valuable. So I like the formulation of paragraph 2 because it both acknowledges new information that has come in and does so not in a way that suggests fear or excess concern but just sort of acknowledges various factors, particularly the financial conditions in the context of others on the upside. The balance is, I think, very nice. On paragraph 3, I agree with President Plosser that it is not clear to me that we had new information so that we would want to change the characterization. I see nothing wrong with the characterization that we have there. I am not as concerned as President Plosser is that it makes more of a value judgment. But my question is just why we have made the change. I am happy with either way, but using my criterion that if no information is new why change, I am not quite sure why we changed it. I think it is fine either way. On paragraph 4, I think it is very important to take a step toward balance without going all the way toward balance because it is much too early to tell, as many people have said. Putting the downside risks there makes a lot of sense because of the tradition of the structure. Again, I don’t see any reason to change the overall formulation or the overall structure at this point, particularly when the markets are jittery. I don’t think we should be going about a sort of structural change in the statement. Even if ultimately we might want to think about it, I do not think this would be the time to do it. Also, I like that it is very easy to put on and take off, so that if growth does come back up, we can easily remove the language. If growth goes down, we can move toward balance of risk very easily there if we want to, and as Governor Warsh said, if we drop “predominant,” we cannot get that back. I feel that we are not at a stage—or at least from the discussion around the table and from where I am—where we should do that. Also, I think you would have a very strong reaction in the markets. If the markets saw that we both acknowledged the downside risk and took out “predominant” or even just took out the word “predominant,” that would indicate a much stronger risk and be a much stronger signal that we are going to move more quickly. I do think that this statement as is will lead to a slight increase in expectations of a cut a little earlier, but that’s perfectly acceptable because I can’t see any better way to get the balance right. Thank you." CHRG-111hhrg58044--367 Mr. Green," Well, okay. I don't see the logic in what you say. I will accept what you say, but I am hoping that you can help me with some logic, as opposed to just a statement. Because it's easy to say things, but where it the logic to support the notion that one's credit score is predictive of whether one will have an accident? I don't see it. And I am asking for empirical evidence. Do you have empirical evidence to support this premise? Let's not go to the claims, because if your bills are behind, if you have poor credit and your bills are behind, you haven't managed your affairs well, you have an accident. There is a good likelihood you will use your insurance. So that means there is a good likelihood that you will file a claim. But does it predict that you will have the accident that causes you to file the claim? That's the question. Ms. Fortney. Well, again, I don't know of any studies on that point. What I said, however, is that the insurance companies are pricing according to the likelihood you will file a claim after having had an accident. That is how credit-- " fcic_final_report_full--471 Even today, there are few references in the media to the number of NTMs that had accumulated in the U.S. financial system before the meltdown began. Yet this is by far the most important fact about the financial crisis. None of the other factors offered by the Commission majority to explain the crisis—lack of regulation, poor regulatory and risk management foresight, Wall Street greed and compensation policies, systemic risk caused by credit default swaps, excessive liquidity and easy credit—do so as plausibly as the failure of a large percentage of the 27 million NTMs that existed in the financial system in 2007. It appears that market participants were unprepared for the destructiveness of this bubble’s collapse because of a chronic lack of information about the composition of the mortgage market. In September 2007, for example, after the deflation of the bubble had begun, and various financial firms were beginning to encounter capital and liquidity diffi culties, two Lehman Brothers analysts issued a highly detailed report entitled “Who Owns Residential Credit Risk?” 34 In the tables associated with the report, they estimated the total unpaid principal balance of subprime and Alt-A mortgages outstanding at $2.4 trillion, about half the actual number at the time. Based on this assessment, when they applied a stress scenario in which housing prices declined about 30 percent, they still found that “[t]he aggregate losses in the residential mortgage market under the ‘stressed’ housing conditions could be about $240 billion, which is manageable, assuming it materializes over a five-to six-year horizon.” In the end, of course, the losses were much larger, and were recognized under mark-to-market accounting almost immediately, rather than over a five to six year period. But the failure of these two analysts to recognize the sheer size of the subprime and Alt-A market, even as late as 2007, is the important point. Along with most other observers, the Lehman analysts were not aware of the true composition of the mortgage market in 2007. Under the “stressed” housing conditions they applied, they projected that the GSEs would suffer aggregate losses of $9.5 billion (net of mortgage insurance coverage) and that their guarantee fee income would be more than suffi cient to cover these losses. Based on known losses and projections recently made by the Federal Housing Finance Agency (FHFA), the GSEs’ credit losses alone could total $350 billion—more than 35 times the Lehman analysts’ September 2007 estimate. The analysts could only make such a colossal error if they did not realize that 37 percent—or $1.65 trillion—of the GSEs’ credit risk portfolio consisted of subprime and Alt-A loans (see Table 1, supra ) or that these weak loans would account for about 75% of the GSEs’ default losses over 2007- 34 Vikas Shilpiekandula and Olga Gorodetski, “Who Owns Resident i al Credit Risk?” Lehman Brothers Fixed Income U.S. Securitized Products Research , September 7, 2007. 2010. 35 It is also instructive to compare the Lehman analysts’ estimate that the 2006 vintage of subprime loans would suffer lifetime losses of 19 percent under “stressed” conditions to other, later, more informed estimates. In early 2010, for example, Moody’s made a similar estimate for the 2006 vintage and projected a 38 percent loss rate after the 30 percent decline in housing prices had actually occurred. 36 The Lehman loss rate projection suggests that the analysts did not have an accurate estimate of the number of NTMs actually outstanding in 2006. Indeed, I have not found any studies in the period before the financial crisis in which anyone— scholar or financial analyst—actually seemed to understand how many NTMs were in the financial system at the time. It was only after the financial crisis, when my AEI colleague, Edward Pinto, began gathering this information from various unrelated and disparate sources that the total number of NTMs in the financial markets became clear. As a result, all loss projections before Pinto’s work were bound to be faulty. FOMC20070807meeting--180 178,CHAIRMAN BERNANKE.," “Have increased, credit conditions have become tighter.” And the housing." CHRG-111shrg50815--89 Mr. Ausubel," Credit cards are extremely useful, but that is not an excuse for completely opaque pricing. I mean, the whole issue--lots of other products, price competition works better because, first of all, it is easier to figure out the true price that the consumer is paying, and second, the price is predictable. Most other consumer products do not have any-time, any-reason clauses. Senator Tester. Thank you. Just very quickly, Mr. Chairman. Thank you very much for holding the hearing. Thank you very much for putting your bill in. I will just tell you that you try to teach the next generation the right thing to do. My parents said, you aren't going to have a credit card, and in the days when I got my first credit card, I paid a fee and the interest rates were pretty clear cut. That has all changed now, I think. I know it has changed. But I can tell you that I have so many examples of young people under the age of 35 that get a credit card. They use it, they go on a vacation, their payment comes in late, and the fees and the interest rates take up all the money that was going to the principal. I have got to tell you, that is flat not right. My time has long since run out, but I will just tell you, it is not fair, it is not right, and it is not the way the program should work. People are getting into people's pockets by making it darn easy to sign up with these things, and then if they make one mistake, they put the boots to them. Thank you, Mr. Chairman. " CHRG-110hhrg46596--209 Mr. Garrett," Thank you. Thank you for your hard work and your dedication to this issue. Let me begin with a question that I hear from my district all the time. You sort of touched on it, and I think the answer is probably an easy ``no.'' When you said to one of the other questions how many foreclosures would have occurred had we not done this, and of course you have heard other people say before the bill came along if you don't do it the credit market will crash, and so on and so forth. We did pass the bill, obviously the market still crashed, and what have you. It seemed things didn't really begin to get a little bit of an uptick until you saw the globalization coordinated effort. So the short question is, is there any way to measure what would have occurred had we not taken the passage of this bill? " CHRG-109hhrg23738--165 Mr. Greenspan," Oh, okay. No, I take the correction. There is a cost in that. In other words, in a more general sense, are there people with whom we feel, for moral reasons, we should not trade? In other words, it is a more fundamental question about: What are the conditions which are necessary, voluntary, people or countries, to engage in trade? And it raises a fascinating question of: Is associating with a certain group of people considered sufficiently morally offensive to your own values that you do not want to do it? The issue of imposing standards--not ours necessarily, but some standards--is a version of that. It is a very difficult question. There is no doubt that if you do it, you will have less trade; but that may be what you want. And it is a judgment that implicitly the Congress, again, makes. In other words, the one thing that I have learned over the years, especially being here 35 times, is that it is you who have to answer all of these extraordinary questions and decide what do you do when confronted with choice. And my only criticism would be that sometimes--like everybody else, ourselves included--when confronted with a choice, you would prefer somebody else to do it. But fortunately our system is such that we have to make these choices, and they are not easy. And the one that you raise, I think, is a very legitimate question, as to where your tradeoff is, basically, in that respect. " CHRG-110hhrg45625--155 Mr. Feeney," I want to thank both of you for being here. I know these are difficult times. I actually liked Mr. Ackerman's analogy. But for all too many Americans, this looks like it turns the play on its head. It is Little Orphan Annie who is being taxed to prop up Big Daddy Warbucks. And the average American out there believes very much that is what they are being forced to participate in as part of this proposal. But I want to look at a bigger picture. We have some huge expertise here, and I am going to mention two dirty words, the Great Depression. Virtually every major market crisis in 100-some years in America has been caused by easy credit, a bubble bursting, and then a credit tightening crisis. That is exactly what we are facing now. There were the Roaring Twenties with easy money. And for the last 6 or 8 years, we have had not only very easy money, there is plenty of blame to go around. It has been the United States Congress that passed the Community Reinvestment Act and browbeat every lender they could into making risky loans and then turned around and accused the lenders of being greedy. It is almost amazing, but that is what we do here, unfortunately, almost all too often. Congress also refused to reform Fannie and Freddie, despite the urging of many of us, and Secretary Paulson, for example, you have huge expertise in what happened after the October 29th stock market crash. In this case, we had a subprime lending bubble that started the crisis. But in 1929, the reaction to that was very real, and it wasn't just a failure to provide liquidity. Credit tightened by some 33 percent. The money supply shrank in America. And I know we are trying to fight that. I don't necessarily agree with your proposal. I know what you are trying to do. But simultaneously, Herbert Hoover raised marginal tax rates from 25 percent to 63 percent. This Congress just passed an impending largest tax increase in history. Hoover signed into law the largest anti-free trade act in history, Smoot-Hawley. This Congress has sat on free trade bills, sending a horrible message to our trading partners. There were huge regulatory increases that started in the aftermath of the 1929 market bubble that, in my view, contributed to taking a short-term, 18-month, 2-year recession, and turned it into a 15-year depression before the stock market fully recovered. I believe that the failure to pass an energy bill here is huge. So I would ask you gentlemen, in addition to dealing with the liquidity crisis, as we turn over these enormous regulatory powers and socialize much of the lending industry, even though we have already socialized Fannie and Freddie for all intents and purposes, how do you intend on these other huge issues, tax increases, huge new spending increases which accompanied the aftermath of the 1929 market crash, how do you in the name of fighting demagoguery explain to the average American that what really needs to be done here? This was not, in my view, a huge failure of the marketplace. This was bad policy by the Fed, easy credit, and Congress browbeating people into making terrible loans. Just like investors speculated with other peoples' money in the 1929 market crash, and bet on margin, it is exactly what happened in our subprime crisis. And so my view is that it was horrible government policy, anti-capitalist policy, that largely led to this crisis. I would like you to address as historians and economists, how we can avoid all of these other things, big tax increases, fighting free trade, huge regulatory burdens, socializing much of the market. Back then, it was utilities and other areas. Today, of course, it is the AIG, it is the banking lenders. And I would like you to address the broader picture. How do we avoid taking an 18-month market recession and turning it into a 15-year Great Depression? " FOMC20070807meeting--153 151,MR. MISHKIN., Could you clarify? Are you saying that you would then get rid of “credit conditions have become tighter”? CHRG-111hhrg48674--180 Mr. Posey," Thank you very much, Mr. Chairman. This is fairly elementary. But when we were on a gold standard, it was pretty easy to tell where we stood. Would you agree with that? " FOMC20080625meeting--218 216,MR. KOHN.," I also had a question, Mr. Chairman, and it's on the PDCF. I find some tension in my own attitudes here. Your leaning all over these people not to borrow helps protect the Board's decision that this is unusual and exigent, credit couldn't otherwise be available, and all of that. So it's supportive of that. On the other hand, it sounds really like what we used to do with commercial banks all the time and thought it created stigma in the process. We don't want you to borrow. If you come in and borrow, given that we don't want you to borrow, you must really be hurting to overcome Art Angulo's or Bill Dudley's frown. So I think the more we do this, the less useful this thing is as a backstop in some sense. I don't know. I don't have an easy answer as to how to resolve this tension. " FinancialCrisisInquiry--166 WALLISON: The buyers, the customers. GM, for example—GM was saved. Were there externalities if GM had failed? MAYO: I’m the one who said I don’t think the prudent should subsidize the imprudent. WALLISON: Right. Exactly. MAYO: How you define that is not always easy. I feel like we’ve overdone it, though. WALLISON: OK. I want to—I’d like to go into some other things. Mr. Bass, you laid a lot of the losses in the financial crisis on the question of derivatives, presumably, credit-default swaps. How then do you explain why the credit-default swap market continued to function throughout the entire financial crisis without any obvious disruption of any kind even after Lehman failed? BASS: There are three parts to the derivatives market—the OTC derivatives market the way I think about it. There’s the CDS marketplace... CHAIRMAN ANGELIDES: Excuse me, Mr. Bass. Yield the gentleman an additional two minutes. WALLISON: OK. FOMC20070807meeting--183 181,MR. MISHKIN.," Well, “credit conditions” is more general because it can encompass both price and nonprice." FOMC20070807meeting--185 183,CHAIRMAN BERNANKE.," Well, think of it as being market-traded assets, and “credit conditions” sounds like mortgages, retail type of credit provision. President Hoenig." FOMC20070807meeting--176 174,CHAIRMAN BERNANKE., I think that is a good idea. Credit conditions are becoming tighter. We saw that in the bank surveys before any of this happened. FOMC20080724confcall--48 46,MS. KRIEGER.," So, yes, what we have proposed is that the additional cushion be taken against all loans more than one business day--primary credit and TAF, not seasonal credit. Clearly one could make a decision about where that point should be, and unless you can do it in a trend line, which our systems don't make operationally easy or comfortable for us, there will be a discrete point. An alternative would be to do it at some particular point in time, and there would be costs and benefits. On the one hand, it would make some more comfortable with the collateralization at very short terms. On the other hand, you also want to be comfortable with the incentives that we will create for DIs, if they are collateral constrained, to take loans of the short term that go just up to that point and continue to roll them. For example, let's say that your point was one week. Banks that are not collateral constrained probably would take the longer-term loan. Banks that are collateral constrained, the ones that you probably want to follow most closely, are likely to take the loan for six or seven days and then roll it and roll it and roll it again. " CHRG-111shrg50815--121 PLUNKETT Q.1. Without access to traditional credit, where do you believe that individuals would turn to finance their consumer needs? A.1. As I mentioned in my testimony before the Committee, it is important to note that the lack of regulation can also lead to detrimental market conditions that ultimately limit access to credit for those with less-than-perfect credit histories. Credit card issuers have recently reduced the amount of credit they offer to both existing and new cardholders, for reasons that have virtually nothing to do with pending regulation of the market. Issuers losses have been increasing sharply, in part because of unsustainable lending practices. (Please see my written testimony for more information.) Had Congress stepped in earlier to require issuers to exercise more responsible lending, they might not be cutting back on available credit as sharply right now. Regarding access to affordable credit for individuals with an impaired or limited credit history, CFA has urged mainstream financial institutions to offer responsible small loan products to their depositors. We applaud FDIC Chairman Sheila Bair's leadership in proposing guidelines for responsible small loans and her call for military banks to develop products that meet the test of the Military Lending Act predatory lending protections. Banks and credit unions should extend their line of credit overdraft protection to more account holders. The FDIC has a pilot project with 31 participating banks making loans under the FDIC guidelines for responsible small-dollar lending. Offering affordable credit products is not the only strategy needed to help households more effectively deal with a financial shortfall. Borrower surveys reveal that many households are not using high-cost credit because of a single financial emergency, but instead have expenses that regularly exceed their income. For these households who may not be able to financially handle additional debt burdens at any interest rate, non-credit strategies may be more appropriate. These may include budget and financial counseling; getting help from friends, family, or an employer; negotiating with a creditor; setting up different bill payment dates that better align with the person's pay cycle; and putting off a purchase for a few days. Toward this end, it is very important that banks and credit unions encourage make emergency savings easy and attractive for their low- and moderate-income customers. Emergency savings are essential to keep low-income consumers out of the clutches of high-cost lenders. CFA's analysis based on Federal Reserve Board and other survey data found that families earning $25,000 per year with no emergency savings were eight times as likely to use payday loans as families in the same income bracket who had more than $500 in emergency savings. We urge banks and credit unions to make emergency savings easy and attractive for their customers. Q.2. Do you agree that prudential regulation and consumer protection should both be rigorously pursued together by regulators? A.2. Absolutely. Credit card issuers must do a better job of ensuring that borrowers truly have the ability to repay the loans they are offered. As I mention in my testimony, card issuers and card holders would not be in as much financial trouble right now if issuers had done a better job of assessing ability to repay. This is why CFA has supported legislation that would require issuers to more carefully assess the repayment capacity of young borrowers and potential cardholders of all ages. Q.3. Do any of the witnesses have concerns that moving away from risk-based pricing could result in the subsidization of credit to wealthy yet riskier borrowers, by poorer but lower-risk borrowers? A.3. Under the Federal Reserve rules, card issuers will certainly have to be more careful about who they extend credit to and how much credit they offer. Given the current levels of indebtedness of many card holders--and the financial problems this indebtedness has caused these borrowers and card issuers--it is hard to argue that this is a bad thing. However, the Federal Reserve rules still preserve the ability of card issuers to price for risk in many circumstances, if they wish. They can set the initial rate a cardholder is offered based on perceived financial risk, reprice on a cardholder's existing balance if the borrower is late in paying a bill by more than 30 days, and change the borrower's prospective interest rate for virtually any reason, including a minor drop in the borrower's credit score or a problem the borrower has in paying off another debt. In addition, issuers can manage credit risk in more responsible ways by reducing borrowers' credit lines and limiting new offers of credit. Q.4. Do you believe that borrowers' rates and fees should be determined based on their own actions and not on those of others? A.4. It is certainly reasonable to base offers of credit on legitimate assessments of borrowers' credit worthiness. As I mention in my testimony, however, many of the pricing methods that card issuers have used to arbitrarily increase borrowers' interest rates and fees do not appear to be based on true credit risk, but rather on the judgment of issuers that they can get away with charging what the market will bear. Q.5. Do you think that credit card offerings from the past, which had high APR's and annual fees for all customers were more consumer friendly than recent offerings that use other tools to determine fees and interest rates. A.5. As I mention in my response above, the Federal Reserve rules leave plenty of room for card issuers to price according to borrower's risk, so I do not think it is likely that we will see a return to the uniform, undifferentiated pricing policies of the past." CHRG-111hhrg52397--181 Mr. Johnson," No, no, they are quite different from each other. I think one thing the market has done though is that the pricing of them is very easy to do in terms of everyone is able to price them and come up based on how LIBOR moves and come up with them. " CHRG-111shrg57322--1059 Mr. Blankfein," Sure. Senator McCaskill. OK. Let me ask you this. And by the way, in May 2006, right about when you did that, Office of Thrift Supervision just did a scoop at Long Beach and found all kinds of problems with their mortgages, almost at the exact time you were putting your instrument out. So that is why I question what kind of due diligence was actually going on and how much due diligence you were actually using in telling the buying public what was in these various transactions. In your testimony, you expressed regret that Goldman missed the signs of a system where credit was too easy, and you have said nobody could know when the housing market would crash or how bad it would crash. Looking back, do you think that you all did enough to look at what were in these instruments and how strong they were on their face? Do you think you exposed the kind of problems that these loans, the vast majority of these loans, represented? " FOMC20070807meeting--169 167,CHAIRMAN BERNANKE.," Well, just to say “have increased” and then have the next phrase say “credit conditions have become tighter” also makes no value judgment on whether they’re appropriate." FOMC20070816confcall--88 86,MR. KOHN.," Thank you, Mr. Chairman. Obviously just for the record, I support both of these actions. I do think that there is concern out there about access to credit over time by the banks and it’s holding them back. So I hope that this is useful in giving them some assurance. As I said, there’s certainly no guarantee. I want to underline a point that President Stern made. If we wait for definitive evidence that tighter credit conditions are affecting the economy, it will be too late. So we need to make judgments, as we always do, in terms of forward-looking monetary policy about what conditions today, tomorrow, next week, or the week after, if maintained, would do to affect the economy, and that’s how we have to make our decision. Thank you, Mr. Chairman." CHRG-111hhrg48868--691 Mr. Liddy," It is important to remember at FP, as I said earlier, it really is easy to paint with one brush and color everyone with the same brush. There are people who worked on one piece of FP called credit default swaps. There were people who worked on another area of FP called regulatory capital. There were people who worked on the derivatives book, the $1.6 trillion. For the most part, those are separate people. I am simplifying, but for the most part they are separate groups of people. It is the credit default swap people who, really, and that was a very small number of folks and a very small number of trades. They are the ones who brought our company to its knees. The folks out here in the derivatives book, you know, they are getting tarred and feathered along with everyone else, and they are the ones that we're asking to please, please, wind this book of business down, orderly, economically, and efficiently, so it doesn't cause problems for us. They are the ones who got the retention bonus. " CHRG-110hhrg44901--194 Mr. Bernanke," I can tell you what the legislation says. Under Section 13.3 of the Federal Reserve Act, we can lend to an individual partnership or corporation if conditions are unusual and exigent, and other credit accommodation is not available. So there are some conditions on that, on 13.3, somewhat less restrictive in that respect, but the collateral can only be treasuries or agencies. " CHRG-111shrg50564--10 Mr. Volcker," Well, that is a complicated question that goes to some of Senator Shelby's concerns about what caused the crisis. If I were analyzing this crisis in a substantial way, you have to go back to the imbalances in the economy, not just in financial markets. But as you know, the United States has been consuming more than it has been producing for some years, and its savings have practically disappeared, and that was made possible by, among other things, a very fluid flow of savings from abroad, low interest rates--very easy market conditions, low interest rates, which in turn incited the great world of financial engineering to develop all kinds of complex instruments to afford a financing for businesses, and particularly in this case for individuals, homebuyers, that went on to exceed basically their capacity to pay. And it was all held up by rising house prices for a while, as you know, and everybody felt better when the house prices were rising, but that could not happen forever. And when house prices stopped rising, the basic fragility in that system was exposed. So you had an underlying economic problem, but on top of that, you had a very fragile, as it turned, highly engineered financial system that collapsed under the pressure. I think of it as we built up kind of a Potemkin Village with very fancy structures, but they were not very solid. " FOMC20070807meeting--154 152,CHAIRMAN BERNANKE.," No. “Investors have demanded greater compensation for risk, credit conditions have become tighter for some households and businesses.” All right. No excitement." CHRG-111hhrg67816--260 Mr. Radanovich," I was looking at the new sample disclosure form by the FTC, which I thought was kind of interesting. Can you tell me your opinion of it? It seems it is easy to read. Have you seen it? " FOMC20080724confcall--116 114,MR. ALVAREZ.," The second resolution on the second page: ""The Board finds that conditions in the credit markets in which primary dealers obtain funding continue to be fragile and subject to unusual strain and uncertainties. This fragility continues to threaten the satisfactory functioning of broader financial markets and thus poses significant risks to the economy. In view of these unusual and exigent circumstances, the Board authorizes the Federal Reserve Bank of New York to continue to make credit available to primary dealers through the Primary Dealer Credit Facility, subject to the same collateral, interest rate, and other conditions previously established, until January 30, 2009, unless the Board finds that the unusual and exigent circumstances no longer prevail. The Reserve Bank may extend credit where it has evidence that reasonable credit accommodations are not available to a borrower from other banking institutions."" " CHRG-111hhrg52406--138 Mr. Manzullo," Thank you. The basic facts about your mortgage loan, a 1-page document, it is simple. It is easy, perhaps too simple and too easy for Congress to pass, editorialized by the Washington Post as being the best statement that the consumer understands. When I practiced law, I went through probably at least a couple thousand real estate closings before RESPA, which screwed up America. It has done more harm. We used to close in 20 minutes, and now that you have documents like this, you close in 2 hours. No one reads the dang thing because if you don't sign everything there, you don't get the keys to your house. Mr. Pollock, why hasn't your 1-page form been adopted, and what is wrong with the city that insists upon screwing everything up? How do you like that question? " CHRG-110hhrg46591--428 Mr. Bartlett," Congressman, the executives of my companies feel a heightened and a strong sense of responsibility, a sense of accountability, and a sense of accountability for getting it right and moving forward. I do have to say it is easy to say ``they.'' I am sure that each of the 435 Members of Congress have a sense of responsibility also. " CHRG-111shrg57320--125 Mr. Reich," I grew up in an era where the fundamental principles of credit administration were character, collateral, capacity, and conditions. Senator Levin. You used the word ``anathema'' in your statement. " CHRG-111hhrg49968--110 Mr. Bernanke," I wouldn't go that far, but there are many other issues we face. And I want to say that you have had a lot of experts. And it is easy for us to sit at this table and tell you that you have to solve this problem, and it is a very hard problem to solve. But it is critical that we address that. " CHRG-109hhrg22160--269 Mr. Greenspan," That is the choice of the Congress. I mean, the point is, the wonderful thing about our system is we have elected representatives who have to make these judgments. And if they don't reach you, somebody else made them, and they are easy decisions. You only get the tough ones. " FOMC20081216meeting--133 131,MR. FISHER.," I guess my point is that the way in which it works is that it gives people incentives to be even more conservative in the financial management of their operations. On household credit, do we have a sense of how much shift is taking place between credit card usage and debit card usage? Under these conditions of duress, has that been a noticeable change, or is it just marginal? " FOMC20070807meeting--182 180,MR. MADIGAN.," I just want to point out, Mr. Chairman, that those two clauses seem to overlap to a considerable degree, “tighter risk premiums” and “tighter credit conditions.” It’s not clear to me precisely what distinction we’re trying to draw there." CHRG-111hhrg54873--17 Mr. Foster," Thank you. And I would like to thank Chairman Kanjorski for convening this hearing today to discuss the important topic of how best to reform the credit rating agencies. While I applaud the general thrust of this bill, and I think it signals advanced improvement over today's regulatory environment, there are at least two major areas where I think the bill could be improved. The first major problem that we are wrestling with is the conflicts of interest inherent in the issuer pays business model for the rating agencies. I believe that the best model for going forward is to mimic the way that we handle similar conflicts and oversight of accounting and maybe modeled on the public company accounting oversight board, PCAOB. An oversight board like the PCAOB would be constituted largely or dominantly by users of credit ratings and would have teeth. Specifically, it would have powers to set standards and mandate disclosures, conduct spot checks and investigations, impose civil fines, ban firms and individuals from the credit rating industry. I believe that the PCAOB has been a necessary and sufficient entity to restore the credibility of the accounting industry in the post-Enron area. So the question I will be asking is what, if anything, might be the downside of instituting a similar oversight board for the credit rating industry. The second major problem that I see is the nonuniformity and nonquantitative nature of the language in which the ratings are reported by the CRAs. While the draft bill mandates the CRAs use generally recognized models when arriving at their ratings, I believe that greater detail under various well-defined market conditions would be very beneficial to investors. Specifically, I would emphasize the desirability of, first, standardization of ratings terminology so that all firms report ratings using identical terms. Second, industrywide standardization of stress conditions under which the ratings are evaluated. Thirdly, unambiguous quantitative correspondence between the ratings and the default probabilities under standardized conditions of economic stress. And fourth, standardization of terminology across asset classes so that, for example, a given rating applied to a municipal bond and a corporate bond will have the identical default probability under identical market stress conditions. One specific proposal that I would like to see investigated are what might be called ABZ ratings at a glance in which the three digits of a rating, instead of just being things that are made up, correspond to default probabilities under three different, well-defined levels of market stress. So the first digit, for example, could represent the default probability under normal market stress, the second digit under severe market stress and the third digit represents the default probability under extreme market stress. A 50 percent asset price drop, 10 percent increase in unemployment and so on. So a rating, if this style of ratings had been applied, then the ratings that would be assigned to an intermediary tranche of a mortgage pool, for example, might hold up well under normal market conditions and then collapse at times of stress would be ABZ. And had this sort of language been applied to the ratings of mortgage-backed securities, then the right questions would have been asked and there would have been no way that AAA ratings would have been so freely disbursed. I thank the chairman for convening this hearing and I look forward to working with him to strengthen this critical legislation. I yield back. " CHRG-111shrg62643--29 Mr. Bernanke," I think we do still have options, but they are not going to be the conventional options and so we need to look at them carefully and make sure we are comfortable with any step that we take. Senator Shelby. I want to get into the area of small business lending. Mr. Chairman, I hear reports of a credit crunch for small businesses and calls by other people to initiate more government programs to jump start lending in this area. I have two questions related to small business credit. First, is there some market failure or regulatory failure inhibiting the flow of small business credit which requires even more government intervention? Second, is there any slow down in small business credit because of weaker demand, because of a deterioration in financial conditions of small businesses and values of the collateral that they hold, or because of regulators somehow inhibiting or preventing good loans from being made? In other words, do we know the definitive reason for the slow down in credit flow to small businesses and what is your take? " CHRG-111hhrg53244--125 Mr. Bernanke," In terms of having the same terms and conditions that they had before the crisis, maybe that will never come back, because credit is sort of permanently tightened up in that respect. I am hopeful that as banks stabilize--and we are seeing some improvements in the banking system--and as the economy stabilizes to give more confidence to lenders, that we will see better credit flows. " CHRG-111shrg55117--56 Mr. Bernanke," Thank you, sir. Senator Johnson. Senator Schumer. Senator Schumer. Thank you, Mr. Chairman. I thank you, Chairman Bernanke, for these 2 long days of hearings. This job is a very tough one, and, of course, you are subject to criticism, and that is part of it. And some of it is valid, and some of it I agree with, but I just would remind people where we were 6 months ago--worried that we might enter a Great Depression. And I think the actions that you and others have taken have avoided that. We still have a long way to go, but it is easy to take all the shots, and certainly I have my criticisms. But also we should remember where we were 6 months ago and where we are today and give you some good credit for that. So I thank you for that. Now I would like to talk about credit cards, something I care a lot about. I know Chairman Dodd has mentioned them briefly. And the JEC hearing back in May, we had an exchange about the Federal Reserve's new credit card rules, and I was troubled by the 18-month delay. Senator Dodd and I asked you to use your emergency authority to put the new rules into effect immediately. And we talked about how consumers were suffering from an increase in predatory credit card practices, arbitrary rate increases, and you had said you would look into it. So the first part of my question is: Have you looked into it? It looks to me as if nothing has changed; things are getting worse. Credit card issuers right now are changing fixed rates to floating rates so that they can say when the law takes effect, as the rates go up, well, we are not raising the rates. That is outrageous. That is against the whole intent of the law. They are also increasing fees for balance transfers. They are cutting credit card limits, hiking up interest rates. So I would like to ask you: How do these new advance notification rules help consumers hit hard by this kind of behavior? Isn't it true that consumers slammed with fee or rate hikes have no recourse other than to pay the increase and cancel the card? Canceling a credit card adds insult to injury by lowering a consumer's credit score. So I have a question for you. I do not think we can afford to wait until our legislation goes into effect. Can the Fed take some actions now, which you have the power to do, to deal with these practices, some of which are clearly predatory? " CHRG-110hhrg46594--311 Mr. Wagoner," Yes. The issue is they have, just as we have, been significantly unable to raise credit. The availability of credit to them in the markets has been dramatically reduced. So unfortunately, in order to manage their cash flow to be able to provide wholesale financing at dealers and be able to finance some customers' sales, they have had to severely tighten their credit conditions. They would like nothing better than to get broader access to credit, which they are working on in this case to try to perhaps become a bank holding company to expand their deposit base to enable them to provide more credit. So they would like to have access to more credit and to be more proactive in the marketplace. We are working with other lenders who have a little more availability to see if they could help our customers out. " FOMC20080724confcall--114 112,MR. ALVAREZ.," Yes. The Board also votes on the TSLF. This is on the second page, the third resolution. ""The Board finds that conditions in the credit markets in which primary dealers obtain funding continue to be fragile and subject to unusual strain and uncertainties. This fragility continues to threaten the satisfactory functioning of broader financial markets and thus poses Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes significant risks to the economy. In view of these unusual and exigent circumstances, the Board authorizes the Federal Reserve Bank of New York to continue to make credit available to primary dealers through the Term Securities Lending Facility, subject to the same collateral, interest rate, and other conditions previously established, until January 30, 2009, unless the Board finds that the unusual and exigent circumstances no longer prevail. The Reserve Bank may extend credit where it has evidence that reasonable credit accommodations are not available to a borrower from other banking institutions."" " fcic_final_report_full--491 There were subprime loans and subprime lenders, but in the early 1990s subprime lenders were generally niche players that made loans to people who could not get traditional mortgage loans; the number of loans they generated was relatively small and bore higher than normal interest rates to compensate for the risks of default. In addition, mortgage bankers and others relied on FHA insurance for loans with low downpayments, impaired credit and high debt ratios. Until the 1990s, these NTMs were never more than a fraction of the total number of mortgages outstanding. The reason that low underwriting standards were not generally used is simple. Low standards would result in large losses when these mortgages defaulted, and very few lenders wanted to hold such mortgages. In addition, Fannie and Freddie were the buyers for most middle class mortgages in the United States, and they were conservative in their approach. Unless an originator made a traditional mortgage it was unlikely that Fannie or Freddie or another secondary market buyer could be found for it. This is common sense. If you produce an inferior product—whether it’s a household cleaner, an automobile, or a loan—people soon recognize the lack of quality and you are out of business. This was not the experience with mortgages, which became weaker and riskier as the 1990s and 2000s progressed. Why did this happen? In its report, the Commission majority seemed to assume that originators of mortgages controlled the quality of mortgages. Much is made in the majority’s report of the so-called “originate to distribute” idea, where an originator is not supposed to care about the quality of the mortgages because they would eventually be sold off. The originator, it is said, has no “skin in the game.” The motivation for making poor quality mortgages in this telling is to earn fees, not only on the origination but in each of the subsequent steps in the securitization process. This theory turns the mortgage market upside down. Mortgage originators could make all the low quality mortgages they wanted, but they wouldn’t earn a dime unless there was a buyer . The real question, then, is why there were buyers for inferior mortgages and this, as it turns out, is the same as asking why mortgage underwriting standards, beginning in the early 1990s, deteriorated so badly. As Professor Raghuram Rajan notes in Fault Lines , “[A]s brokers came to know that someone out there was willing to buy subprime mortgage-backed securities without asking too many questions, they rushed to originate loans without checking the borrowers’ creditworthiness, and credit quality deteriorated. But for a while, the problems were hidden by growing house prices and low defaults—easy credit masked the problems caused by easy credit—until house prices stopped rising and the flood of defaults burst forth.” 60 Who were these buyers? Table 1, reporting the number of NTMs outstanding on June 30, 2008, identified government agencies and private organizations required by the government to acquire, hold or securitize NTMs as responsible for two-thirds 60 Raghuram G. Rajan, Fault Lines , p.44. 487 of these mortgages, about 19 million. The table also identifies the private sector as the securitizer of the remaining one-third, about 7.8 million loans. In other words, if we are looking for the buyer of the NTMs that were being created by originators at the local level, the government’s policies would seem to be the most likely culprit. The private sector certainly played a role, but it was a subordinate one. Moreover, what the private sector did was respond to demand—that’s what the private sector does—but the government’s role involved deliberate policy, an entirely different matter. Of its own volition, it created a demand that would not otherwise have been there. CHRG-111hhrg51698--617 Mr. Moran," Thank you so much. I have a couple of questions. I explored this with the previous panel and what I think I see in this draft, and what I hear from a number of witnesses, is that we are headed down the path of a forced clearing with a narrow exemption. And I just wanted to explore one more time what does anyone think the alternative should be to that. Is there an easy way to summarize that? " CHRG-111hhrg51592--235 Mr. Bachus," On Page 4 of your written testimony, you say, even in the midst of the unprecedented economic conditions, that Realpoint was able to issue accurate credit downgrades 6 to 9 months sooner than your largest competitors. " CHRG-111hhrg48868--585 Mr. Liddy," Yes, that's a hard one to answer, sir. I understand the intent of the question. The people at FP, it is easy to paint with one brush and capture everybody. In fact, there are a lot of really good people up there. They are basic Americans, they want to do a good job for us. The trades that were done that brought us to our knees, that was a very small number of people-- " CHRG-111hhrg52406--69 The Chairman," Professor Warren, if you want to answer the question, we will find some opportunity to do so later on within her allotted time. The gentlewoman from California. Ms. Waters. Thank you very much, Mr. Chairman. I would like to start with kind of a basic question about oversight and regulation. I sincerely believe that there are some products. They have often been referred to, because of this subprime meltdown that we have had, as ``exotic products'' that were offered in the markets, such as Alt A loans and option adjustable rate mortgage, etc. There appears to be a feeling or an understanding or a basic way that the financial services community works that says you cannot deny products, that you can regulate them, no matter what someone decides to market that it is no so bad that it could be banned, that it could be stopped, that it could be disallowed, but whatever comes on the market, we will regulate it. How many of these products can reasonably be regulated? We discovered that there was very little regulation going on with these exotic products that came on the market. There was no real oversight. Nobody seems to have had to introduce them to any agency to say, you know, this is what we are about to do. They did not seem to know what was going on. What about that? Are there any products that are so bad that there needs to be some way to stop them altogether or do we go along with the idea that, well, if new products come on the market--1,000 of them or 2,000 of them--it does not matter, and we will regulate them? I would like someone to speak to that. Let me ask Ms. Seidman what you think about that? Ms. Seidman. Thank you, Congresswoman Waters. You know, I think one of the questions that we have to ask is: What is a ``product'' and what is a ``term?'' So, clearly, no one would ban mortgages or credit cards. On the other hand, I think we have a system that recognizes that banning terms is very much within the power of the regulator. In fact, interestingly enough, the Fed actually banned double-cycle billing, which Professor Warren just described. Are there some products that are so bad they should not be allowed? You know, I think there are, but I also think it is incredibly important that we understand what the needs of the population are and how those needs are going to be met. I do not happen to like payday lending. When I was at OTS, we made sure that the institutions we regulated did not do that. On the other hand, in a world in which we have discouraged savings, in a world in which we do not make saving easy, in a world in which there are a lot of people, immigrants and nonimmigrants, who do not have easy access to our mainstream financial institutions, we need to figure out something else so that they can have access to well-priced, well-structured, short-term credit. There are both mainstream institutions, credit unions in particular, some banks and some non-banks that are doing that. So the question is: What is the function that needs to be served, and how can that function be served in a responsible way? That is the question that this new agency is going to have to answer, and I think it is a creative way and a really important way to think about consumer protection. Ms. Waters. Thank you. Mr. Yingling, we are being told--and it is being whispered and talked about in the back rooms and in other places--that the bankers are going to have a big pushback on this agency as to what it stands for and what it is supposed to do. What is it about the agency that would cause the bankers, one, not to have a consumer protection agency as you understand it? " FOMC20081216meeting--168 166,MR. DUDLEY.," You can look at credit ratings, for example, or what's happening to their profitability. It is highly likely that the strains in the CP market are more dramatic than any change in the underlying financial condition of the A2/P2 borrowers. " CHRG-110shrg38109--143 Chairman Bernanke," The general principle I was trying to address was the insecurity the people feel about job loss and job change. And I think it would be beneficial if we could reduce that insecurity. One way to do that would be to increase portability of benefits across jobs. There are many ways to do that, so I am not taking a specific means. Wage insurance is an interesting idea that has been advocated by a number of economists. Again, I am not sure I can take a specific position on it. One of the things I said, and I should reiterate, is that it is easy enough for me to say we should address these issues. The actual implementation is quite difficult. These are very complex problems. I just urge Congress to look at them and try to get as much good input and advice as they can in thinking about how to best address these issues. Senator Reed. A final issue, which is the Earned Income Tax Credit, which seems to me to be a very efficient way to deal with this issue that has been the constant source of our discussions this morning, inequality of wages, inequality of opportunity. Is that something that we should be looking at seriously, to expand it? " FOMC20070807meeting--19 17,MR. POOLE.," I have two questions. First, does the New York Fed have what I might call material nonpublic information about firms that would suggest that there is more difficulty than we see in the newspapers? That is one question. The other question has to do with the distribution of views among dealers about probable Fed policy. There is obviously an arbitrage relationship between, let’s say, a two-year Treasury and these futures markets. My sense is that probably what is going on here—and I will use the two-year as the example—is a flight to safety. People are trying to shore up their liquid assets in case they have to sell some stock into the market, so they are trying to hold more of that. But there is no easy way for those on the other side of that market to go short and push that yield back to where the best-informed people think it will be once we are past this turmoil. So what we may be seeing is less a reflection of expectations about future policy actions than a flight to liquidity as a desperate effort— “desperate” may be too strong—to shore up the liquidity of a balance sheet, and there is no easy way for people to go on the other side. Those are the two questions I have." CHRG-110hhrg34673--214 Mr. Bernanke," That is a difficult one. We don't want to rule out the possibility that when someone's creditworthiness drops for a variety of reasons, that their creditors get that information and use it. However, I think some of the concern about universal default provisions is that people don't get enough warning or notice that this condition is going to kick in. So that might be one direction to go, which is to increase the amount of warning that consumers get when their credit histories deteriorate and when that may affect their pricing and their credit cards. " CHRG-110hhrg41184--107 Mr. Bernanke," Well, there is an interaction between the economy and the financial system, and it is perhaps even more enhanced now than usual in that the credit conditions in the financial market are creating some restraint on growth, and slower growth in turn is concerning the financial markets because it may mean that credit quality is declining. And so this financial accelerator or adverse feedback loop is one of the concerns that we have and one of the reasons why we have been trying to address those issues. " FOMC20070918meeting--120 118,MR. STERN.," Thank you, Mr. Chairman. Let me make a few comments about current economic conditions and then talk a bit about the outlook. By way of overview, I will say that I largely agree with the Greenbook, both about the current quarter and about the near-term outlook, in any event. The current quarter does look as though it is going to turn out to be certainly respectable real growth of 2½ percent or perhaps a bit more. The anecdotes from our District that relate to the third quarter seem to be consistent with that. Employment has been sustained, and if anything, the reports of the scarcity of skilled labor have probably increased. In fact, some of our directors have speculated that perhaps the aggregate employment gains have been restrained by that availability issue. The largest bank in our District and several others say that, based on what they are seeing, consumer spending and consumer unsecured borrowing are proceeding normally. Repayments are proceeding normally, and credit quality on the consumer side is in good shape. The one exception to what I would describe as a generally positive picture is what we are hearing in the nonresidential construction sector. I don’t want to make too much of this, but I have a sense that it is significant. Some of the large developers in the District have reported that, because of the change in financial conditions that has occurred in the past month or two, some projects are clearly being postponed. Whether they will ultimately be cancelled remains to be seen, but there certainly have been some effects there. Turning to the outlook, I think that the outlook for real growth over the next several quarters is less favorable than it was formerly. I admit that it’s a stretch to get there, if we rely on our familiar models to produce that result. Nevertheless, I take a cue from the comments I made a moment ago about nonresidential construction. It looks as though that will be somewhat slower than I earlier anticipated because of changing financial conditions. I would guess that we would see the same thing in outlays for equipment and software, so I’m expecting a less favorable performance there. As far as the housing sector is concerned, it seems to me that, given the inventory of unsold homes, even if financial conditions improve and improve relatively quickly, housing is going to exert a depressing effect on the economy for quite some time to come, just because of the inventory overhang. More broadly, the changes in the cost and availability of credit that we see are likely to hamper the economic expansion for several quarters. So I have marked down my forecast accordingly, based on changes in the factors I cited—namely, a somewhat less favorable outlook for nonresidential construction and ultimately for spending on equipment and software, prolonged weakness in the housing sector, and a somewhat less favorable outlook for consumer spending as a consequence of changes in credit cost and credit availability. On the inflation front, the incoming information is slightly more favorable than I had earlier expected, and so on margin I have adjusted my forecast there as well. I had been expecting a diminution of core inflation as a consequence of the ebbing of transitory factors and of a moderately restrictive monetary policy. It appears to me now that the decrease in underlying inflation is occurring a little sooner than I had anticipated, and I think this is obviously a positive development from a number of perspectives, one of which is that it is potentially significant as it gives us a little more maneuvering room on the policy front if, in fact, it is sustained. Thank you." CHRG-111hhrg56767--40 The Chairman," Mr. Feinberg has arrived, and I just want to thank him--it hasn't been an easy day for him--and just reassure him that the next witness will be Mr. Alvarez, so he will have at least 7 or 8 minutes to collect himself. We understand that there was, literally, a train wreck, and we thank you for making every effort to come here. I apologize, Mr. DeMarco. Please continue. " CHRG-109shrg26643--82 Chairman Bernanke," Well, actually we are looking for them to give us statistical indicators of their own loss experience in their past credits. And part of the process will be validation. That is, they have to show us that their numbers were derived from their actual experience over a period that encompasses both strong and weak credit conditions and that they are using those models for their own internal analysis of capital. So there will be a lot of checks and we will continue to work with the banks and with the Congress on this issue. " FOMC20070807meeting--186 184,MR. HOENIG.," I’m okay if you want to put “premium,” the Vice Chairman’s language, in there. But I think that the markets have become more volatile, and nothing is wrong with saying that, and credit conditions have tightened, which is a fact, and people are thinking about the volatility of the markets. So that is on their minds. We’re acknowledging it, as you said, and so I was comfortable with the language." FOMC20080310confcall--37 35,MR. ROSENGREN.," I just want to follow up on one of Bill Dudley's comments. I noticed in the terms and conditions that it included that the New York Fed reserves the right to reject or declare ineligible any bid entirely at its own discretion. Under the TAF, we require that people be qualified under the primary credit program. Are we planning on using a credit standard equivalent to what is done for the TAF for the broker�dealer community? Do we currently have the capacity to make that determination? " CHRG-111hhrg48868--192 Mr. Capuano," Thank you, Mr. Chairman. Ladies and gentlemen, I think I heard most of you say that you didn't have oversight over CDS, but I didn't hear any disagreement with Mr. Ackerman's general description or the general belief that credit default swaps are all some sort of insurance. And I take that to be an accurate assessment of what they are. They're just insurance with nothing backing it up. If that's what they were, I would then argue that you did have the authority to oversee these. If we were a part of the holding company, it was your responsibility at the OTS to include any activity that might have impacted the holding company. If it was part of the insurance company, the State regulators had a responsibility to oversee some sort of insurance; and, certainly, the credit rating agencies had some responsibility to see that this game wasn't going to undermine investors' confidence. So I know nobody wants to take fault for it, and again, I don't think it's actually anybody's fault. It's everybody's fault. Credit default swaps were simply a way to get around any sort of regulation, any sort of oversight, and everybody here allowed it to happen. Everybody allowed it to happen. To say you didn't have any authority to me is simply an easy way out and a wrong way out. But I do want to know now. I mean, okay, it's done. We are where we are. I presume that everybody, you're here today, because you know a lot about AIG, and AIG to me is just one of the many problems, but it's the one that we're talking about today. I presume that even though the OTS isn't technically the regulator, I presume you are still keeping an eye on it, because in theory there will come a time when you will be the regulator again unless we change everything. So I don't think you probably just dropped the ball. I hope you have. And that being the case, I would like to know when do you think that the path that we are on now should, has a reasonable expectation, of leading AIG back to profitability at some point of stability; and, if so, when. And I'm not saying when, tomorrow, but within a year, 2 years, 10 years, 100 years, never. Mr. Polakoff? " FOMC20070918meeting--298 296,MR. POOLE.," I understand that, but that can be different from the current target rate that’s in effect right now. That’s my point. This rate could be below the current target rate, and that seems to me to create an issue that we are going to have to be prepared to explain, and I’m not so sure that’s going to be easy to explain. At any rate, I’ll leave that on the table for the moment." CHRG-111shrg52619--88 Mr. Fryzel," Thank you, Senator. Paramount to NCUA is the safety and soundness of the funds of all our 90 million members in credit unions across this country, and in an effort to maintain their confidence is not an easy task, and we have made every effort to do so by public awareness campaigns. Certainly the action by Congress in raising the $250,000 limit has been fantastic in regards to the safety and their ability to think that their funds, or to know that their funds are safe. We tried to draw the fine line in letting them know that, yes, there are problems in our financial structure, but we are dealing with them and we are going to use the tools that we have to make sure that things get better. And when this economy turns around, financial institutions are again going to be in the position where they are going to be able to serve these consumers in the way they have in the past. So yes, Senator, it is a fine line, but I think it is one that we have to keep talking about. We cannot let anyone think that there are not problems out there. We have to tell them we are in a great country. This economy does come back and everything is going to be better in the future. Senator Reed. Mr. Tarullo. " CHRG-110shrg50420--58 Mr. Dodaro," Well, that is one of the reasons we would suggest, if Congress decides assistance is warranted and provided that there be a short-term mechanism to get the money, most of the plans--or the two plans that require immediate assistance, the General Motors plan and the Chrysler plan, call for help during the--immediately, but also the January, February, March timeframe, first quarter. You know, we believe that there is sufficient expertise now available in the Federal Government to get a board together to at least look at, while there may be an initial outlay--and that initial outlay ought to be conditioned on certifications by the automakers that no other credit is available to them and other conditions, but then they could immediately focus on the cash-flow positions of those entities and then take a look at the longer-term issues associated with restructuring. That would buy enough time to do that. Senator Reed. Thank you. Thank you, Mr. Chairman. " FOMC20060808meeting--118 116,MR. MOSKOW.," Thank you, Mr. Chairman. The incoming data have heightened my concerns about inflation. I think it’s true, as a number of people have mentioned around the table, that inflation expectations have not moved up. The markets seem pretty confident that we’re going to be successful in fighting inflation. But as Kevin Warsh said, the markets can be pretty fickle. We’re going to get some further bad news on inflation in the coming months, and I hope the markets will maintain their confidence in the Federal Reserve. But their confidence in us could change as the news continues to be bad in the coming months. Also, I think we have to ask whether our failure for two years now to keep inflation inside what many of us have said is our comfort zone—1 to 2 percent—is going to weigh eventually on the assessment of the markets and their confidence in the Federal Reserve. I’m concerned that the public’s confidence in us may begin to waver if we don’t express our readiness to tighten if inflation doesn’t head down soon. It’s not clear to me that we’ve put restrictive-enough financial conditions in place to put inflation on much of a downward path. According to the Bluebook, the fed funds rate is close to neutral. In the Bluebook’s longer-run simulation, the optimum policy requires further rate increases to put us on the path to 1½ percent. We won’t get there just staying where we are now. I realize it’s a very close call, and everyone has mentioned that; but on balance, I would prefer to raise rates 25 basis points at this meeting. I won’t repeat all the comments that Cathy, Charlie, and Jeff made. I think they were very persuasive. It would surprise the markets, but we shouldn’t be doing what the markets expect us to do. We should be doing, as someone said, what’s right for the economy and for the American people. It doesn’t appear that an increase will be the consensus coming out of this meeting. I’d just add that, if we do pause, it’s not going to be easy for us to start again. I don’t think we should kid ourselves about that. We’re going to be accused of whipsawing by the markets, and we’ll take a lot of criticism. So we’re going to have to take a very tough stand if we decide to raise rates again. It’s not going to be easy, and we should just be prepared to do that. Looking ahead, I’d say that if we determine that factors are not reducing growth too much and if inflation does not appear to be moderating, then we’re going to need to increase rates further to coax inflation back toward price stability. We have to make it clear in our public statements that we’re prepared to do that. If we do go with the pause, then I certainly agree with Don Kohn’s recommendation that we should use the language from section 3 of alternative C and move it to section 2 of alternative B. To omit the reference to high levels of resource utilization, when we’ve had it in our past statements, would be a serious error." CHRG-111shrg55117--128 PREPARED STATEMENT OF SENATOR JACK REED Today's hearing provides an important opportunity to hear from Chairman Bernanke on the overall health of the economy, labor market conditions, and the housing sector. These semiannual hearings are a critical part of ensuring appropriate oversight of the Federal Reserve's integral role to restore stability in our economy and protect families in Rhode Island and across the country. I continue to work with my colleagues on this Committee to address three key aspects of recovering from the financial crisis. First, we must stabilize and revive the housing markets. With estimates of more than a million foreclosures this year alone, we must recognize this as a national emergency no different than when banks are on the verge of failing. One in eight mortgages is in default or foreclosure. These are more than statistics. They represent individuals and families uprooted, finances destroyed, and communities in turmoil. We need to keep pushing servicers to expand their capacity and hold them accountable for their performance. And we need to make the process more transparent for homeowners. Second, we need to create jobs, which the American Recovery and Reinvestment Act is already doing throughout the U.S. Although there have been some positive signs in the economic outlook, the unemployment rate in Rhode Island and nationally has continued to climb steeply. In the 5 months since you addressed the Committee in February, the national unemployment rate has risen from 8.1 percent to 9.5 percent, and in Rhode Island it has surged from 10.5 percent to 12.4 percent--the second highest in the country. I will soon introduce legislation to encourage more States to use work share programs, similar to our program in Rhode Island, which provide businesses with the flexibility to reduce hours instead of cutting jobs. Third, we need to stabilize and revitalize the financial markets. We've made significant progress in this area, but we need to continue to monitor these institutions to ensure they remain well-capitalized and are able to withstand market conditions much better than they did in the recent past. And we need to be smart about the Federal Reserve lending programs to get our credit and capital markets once again operating efficiently and effectively. This is especially true for small businesses, our job creators, which are the key to our Nation's economic recovery. Finally, complimenting all of these is a need for comprehensive reform of the financial regulatory system. We face several major challenges in this area, including addressing systemic risk, consolidating a complex and fragmented system of regulators, and increasing transparency and accountability in traditionally unregulated markets. It is important to recognize that our economic problems have been years in the making. It will not be easy to get our economy back on the right track. But in working with President Obama we can begin to turn the tide by enacting policies that create jobs and restore confidence in our economy. ______ CHRG-111shrg57923--3 Mr. Tarullo," Certainly, Senator. A number of other regulators and overseers around the world have already begun to address the issue of information, among them the various organs of the European Union and the United Kingdom, the Bank of England. The G-20 itself has issued a couple of recommendations that are particularly salient to this question on developing a template for reporting of information of the large internationally active financial firms. Now, this is, of course, not an easy undertaking for any one nation much less for the world as a whole, but it is something which the Financial Stability Board has taken on as a task. There have been some preliminary discussions on how to organize the work of trying to see if we can come to agreement on a template for reporting of the largest, most globally active financial institutions. It is far too early to report progress there, Senator, but I can say that the effort has been launched. Senator Reed. Well, thank you, Governor. As you know, as we are proceeding down, and I think appropriately so, a legislative path which we hope will incorporate this systemic collection of information, I have got legislation in--and, in fact, I want to thank Dr. Mendelowitz and Professor Liechty for their assistance and help. But this is going to have to be an effort that goes beyond the United States to understand that, but I think it is important that we begin here. Another aspect of this international question is the issue of sovereign behavior. The Greek Government now is in a very serious crisis which is rattling the markets. There also is some indication that another one of our favorite topics, derivatives and credit default swaps, have come into it. Apparently, there are reports that investment banking firms have helped them legally avoid treaty obligations under Maastricht, et cetera. But the long and the short of it is, do we also have to include sort of sovereign entities in terms of data collection? " CHRG-111hhrg55811--177 Mr. Campbell," Let us get to that, because homogenizing derivative products is not an easy thing. Obviously, everyone even in the bond market you haven't been able to homogenize and make an exchange trade and so forth. How much would fit in this standardized? How much homogenization is there going to be? And is there, then, incentive for me to create products that do not homogenize, because even though there is transparency, there can be more margins in something that is outside of this--well, not exchange, but outside of this clearing than would be inside the clearing? " CHRG-110hhrg44901--33 Mr. Manzullo," Thank you, Mr. Chairman. Chairman Bernanke, earlier this week you took an action to crack down on a range of shady lending practices that have hurt the Nation's riskiest subprime borrowers and also have caused a tremendous amount of economic distress in this country. Among other things, the Fed issued regulations that would prohibit lenders from lending without considering the borrower's ability to repay and also would require creditors to verify their income and assets at the time of the borrowing. These are pretty basic. Although hindsight is a 20/20 issue, and it is easy to sit here and say the Fed should have done this a long time ago, the evidence of this housing bubble has been going on for some time. And my question is, what took the Fed so long to act? And then the regulation you are coming out with is not going to be effective until October 1st of next year. Those are the issues just involving in the subprime borrowers. As to the regular borrowers, you came up with another landmark regulation that says, whenever a borrower gives a check to the bank that the bank has to credit it that day to the borrower's account. I mean, this shows knowledge of some very basic problems that have been wrong in the housing industry. But what took the Fed so long to act? And why wait 15 months before the regulations go into effect? " FOMC20080130meeting--188 186,MS. PIANALTO.," Thank you, Mr. Chairman. In my view, economic conditions have deteriorated significantly since our December meeting. Taken as a whole, the stories that have been relayed to me by my Fourth District business contacts have been downbeat, and several of the contacts are concerned that we may be slipping into a recession. I'm hearing that consumer spending has declined appreciably since the soft December retail sales numbers were reported. The CFO of one of the nation's major department store chains told me last week that her company's January sales are shaping up to be the worst that they have seen in the past twenty years. She said that they had already cut back some of their buying plans because of the weak holiday sales, but after seeing the numbers for the first three weeks of January, she is concerned that they have not cut back buying plans enough. In December I had heard some upbeat assessments about the demand for capital goods and exports, but in January the incoming numbers are softer, and expectations for the coming year are less optimistic than they were just a month ago. I'm also concerned that I'm now detecting the first signals of a credit crunch. Bankers in my District tell me that they're finding it much more difficult to issue debt and that they are safeguarding their capital. I've heard several motivations for this, depending on the institution. Some bankers are simply preparing for further losses. Some are expecting to have to bring some downgraded assets back onto their balance sheets. Even those bankers who have adequate capital say that they have become much more disciplined about how they're going to allocate that capital. Collectively, the concerns that bankers have expressed to me about capital have convinced me that credit will be less available and more expensive than it has been in quite a while. Deals that bankers would have done for creditworthy borrowers not long ago are simply not being done today. Of course, it's possible that nonbank financial companies will step in and fill the gap, but it is not clear to me that they have the capital and the risk appetites to do so. These developments have had a significant influence on the economic projection that I submitted for today's meeting. Like many around the table, I continue to mark down my outlook for residential and nonresidential investment in response to the incoming data and also in response to greater business pessimism about the economic prospects. In addition, I've built in a sharper and more protracted slowing in consumer spending stemming from greater deterioration in the household balance sheet and tighter credit market conditions. These adjustments have caused me to cut my 2008 GDP growth projection about 1 percentage point since the December meeting, and some of that weakness spills over to the out years. If credit conditions deteriorate further than I have expected, then my projection would more closely resemble the persistent weakness alternative scenario described in the Greenbook. But that isn't my projection for the economy. Rather, my projection is roughly in line with the Greenbook baseline. My inflation outlook hasn't changed much from where it was in December--or October, for that matter. Like the Greenbook, I still project inflation to moderate as commodity prices level off and business activity wanes, but the risks to my inflation outlook have shifted to being weighted to the upside. The December CPI report was not much improved from the troubling November data, and my business contacts continue to report that commodity prices are being passed downstream. So I have less conviction in the inflation moderation than I did a month ago. That said, the downside risks to the economy still dominate my thinking about the outlook today. I do believe, however, that our policy response to date combined with an additional rate cut tomorrow will allow the economy to regain some momentum as we move into the second half of 2008. Thank you, Mr. Chairman. " CHRG-110hhrg46594--408 The Chairman," Thank you. Professor, one side point, on putting other members on the board, we run into the problem of the appointments clause. You cannot give a board that has any power any membership other than a presidential appointee. We could add a presidential appointee who was not in the Cabinet but it couldn't be a congressional appointee. That is why in the TARP we have two boards, one that is congressionally appointed that is oversight but no power and then one with power but it is all the Administration. So it doesn't do as much good. But beyond that, part of your mandate at Columbia, in which you have done such a good job, is on the whole question of sustainability. And one of the criticisms we have in the auto industries has come understandably from people concerned about the environment because of their past record. One proposal we got--in fact it is the Bush Administration's approach, which is to take away from the $25 billion that was already voted the conditions on that that were--that said it had to be used to promote energy efficiency; that is, their view is all right. We gave them $25 billion for the specific purpose of retooling credit deficiency. Let's just take those conditions off. What would your response be to that? " FOMC20081216meeting--377 375,MR. MADIGAN.," ""The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to � percent. Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further. Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters. The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasuries securities. Early next year, the Federal Reserve will also implement the term assetbacked securities loan facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity."" " CHRG-111shrg50814--97 Mr. Bernanke," Well, the two principal steps that are being taken, first, is the set of measures to try to reduce preventable foreclosures, which will reduce the supply of homes in the market and would be helpful to prices and construction. The other step has been the Federal Reserve's concerted efforts to lower mortgage rates by the purchase of GSE securities. We have had some success in that direction. So house prices are down quite a bit, obviously, and interest rates are pretty low. So affordability is not the issue it was a few years ago. So at this point, I would recommend focusing broadly on the economy and the financial system as a whole. People are not likely to buy houses when they are feeling very unsure about their jobs, for example. So the more we can do to strengthen the overall economy and stabilize the financial system, and along Senator Bayh's line, restore confidence, I think that will be the best thing to get the housing market going again. Senator Martinez. In December, the Federal Reserve reduced the fund rates further, and then obviously you noted on February 18 that widening credit spreads, more restrictive lending standards, and credit market dysfunction have all worked against the monetary easing and have led to tighter financial conditions overall. What other tools is the Fed employing to ease credit conditions and to support the broader economy? " CHRG-110shrg50416--145 Chairman Dodd," We are in a pro forma session. You may decide to do something here. I have got to keep an eye on you. Senator Corker. Is there any need for the Federal Government whatsoever to be involved in the secondary market? It is a simple, easy--I mean, it makes our exotic derivatives look like, you know, elementary stuff. Is there any reason whatsoever for the Federal Government to be involved in the secondary market? " CHRG-111hhrg48867--269 Mr. Plunkett," Well, I am going to talk about one aspect of this issue that hasn't been addressed: the need to assure that attempts to spur credit availability, whether through larger institutions or smaller institutions, are offered on a sustainable basis. The TARP program, the TALF program--we are concerned, particularly with the TALF program, that it may end up subsidizing, for instance, credit card loans with terms and conditions that are not sustainable for consumers. So I think that is an important aspect to the issue that we should think about. " CHRG-111hhrg54869--16 Mr. Volcker," When I comment that I think banks should be restricted in their, what I think of as truly capital market impersonal activity, it is pretty easy to talk about hedge funds and equity funds because they are identifiable institutions. Proprietary trading is not an identifiable institution in the same way, although many financial institutions will have a proprietary trading desk. That is the way they label it themselves. " CHRG-110hhrg45625--95 Mr. Bernanke," Well, we really had two stages in this credit cycle. The first stage was the write-downs of subprime and CDOs and those kind of complex instruments. We are now in the stage, with the economy slowing down, where we are seeing increased losses in a variety of things, ranging from car loans and credit cards, to business loans and so on. And that is going to put additional pressure on banks. It is another reason why they are pulling back, building up their reserves, building up their capital, de-leveraging their balance sheets, and that is going to prevent them from providing as much credit as our economy needs. Ms. Velazquez. Thank you. Secretary Paulson, we are hearing about small business loans being called in, and up to a third may have a callable provision and not be delinquent. Lenders are also reducing credit to entrepreneurs, and we are aware that the Federal Reserve reported that 65 percent of lending institutions tightened their lending standards on commercial and industrial loans to small firms. Given these challenging conditions, how will the current proposal specifically address the challenges facing small business? Before, you said in your intervention how this is going to help small businesses. Well, they too are victims now of the financial market mess that we are in. " FOMC20070816confcall--63 61,MS. YELLEN.," Thank you, Mr. Chairman. I want to say that I strongly support the proposal that you’ve made, both the changes to the primary credit program, and also I would strongly endorse the statement that you just recommended that the Federal Open Market Committee put out. I’ve been doing my best to follow developments in financial markets in recent days, and it seems very clear that we have a situation of almost complete illiquidity in the asset-backed commercial paper market and in asset-backed markets more broadly. Although I agree with President Plosser that the proposed changes to the operation of the discount window and the cut in the discount rate are not certain to succeed in regenerating the functioning of these markets, I think this is a very well reasoned, thoughtful, creative program that has as good a chance to succeed as anything that certainly I could dream up. So I strongly support it. I could go along with a larger cut in the discount rate, but I understand the reasons that you’ve given for making it a 50 basis point cut. So I strongly support that. I also think it is highly appropriate for the FOMC to issue this statement that you have suggested. First of all, it is just straightforward that the outlook has deteriorated. We’ve developed a credit crunch. If liquidity isn’t quickly restored in these markets, we are looking at a credit crunch—signs of it are everywhere. Just to see that, Countrywide itself is 20 percent of the market, and it announced that it is tightening credit standards. Every day we hear about companies that are trying to finance prime quality jumbo mortgages and cannot get the financing to do that and are tightening standards. Although we may not have yet seen data suggesting that these changes in financial conditions are having an effect on economic growth, I think any forward-looking assessment would suggest that tighter credit conditions have to have that effect. So I certainly support the recognition of that, and I can easily imagine that we will be cutting the federal funds rate in the not-too-distant future." FinancialCrisisInquiry--211 So – Do I understand what you’re saying is that the Wall Street banks are now calling for more regulation, which you think are going to redound to the detriment of the community banks who already are adequately regulated. CLOUTIER: Correct. I mean, you know, one example is if they had to live with my capital levels. I had 12 percent capital. When I heard them talk about their capital levels here earlier today, I wondered how in the world they got away with that. Because I guarantee you, if I walked and told my regulator I was going to have 6 percent capital, I’d have a C&D in the morning on my desk. You know, it’s an unfair system. So when they say send more regulation, more regulation only means that’s more stuff that I don’t have to worry about and that’s an easy way to go out the back door. You know, when we had the crisis at Enron, they passed—which by the way, Citicorp and them were deeply involved in. You know, they paid big fines for. It didn’t affect them at all. It was crushing to small business. It was a crushing event. Gramm-Leach-Bliley, when they changed the rules, it didn’t affect them. It affected us. So more regulation usually doesn’t have much effect. My question is, and the question this commission should ask: Why wasn’t the regulations on the books enforced? And then that would be an amazing question to ask. And I think most of the answer is is that they’re a member of the FAC they’re very closely interlinked into the Washington circles. GRAHAM: Ms. Gordon, you made some very strong statements about the fact that there was a preference given to the worst mortgages and actual economic incentives to create harsh conditions and possibly overprice to the consumer mortgages. What is—do you have some evidence to substantiate those charges? CHRG-110hhrg41184--26 Mr. Bernanke," Well, they certainly need to know the interest rate and how it varies over time and what that means to them in terms of payments. And they also need to understand other kinds of penalties or other fees that might occur if they violate certain conditions or other things occur. So they need to have a good understanding, not only of how they use a credit card for example, but also what the cost might be so they can make an informed judgment. " FOMC20070509meeting--63 61,MS. PIANALTO.," Thank you, Mr. Chairman. The economy from the perspective of the Fourth District isn’t materially different from the way I heard Dave describe national conditions. Manufacturers in the District generally report modest but steady growth. In particular, metals producers and their suppliers report strong orders and production. My business contacts are telling me that capital investment is a bit soft, but it should not at this point pose a serious problem for the overall economy. I’ve had several meetings with homebuilders throughout my District in the past few weeks, and they confirmed some of the information that we see in the national data—sales are still very anemic, and the inventory of unsold homes remains quite high. They also shared some information that is not easy to pull from the national indicators. For example, sales of starter and lower-end homes are particularly slow, in part because lending standards have been significantly tightened. This means that there has been a shift in the composition of homes sold toward the upper end of the price spectrum, causing the reported sales-price data to be a little inflated. The builders I spoke with assure me that price discounts are occurring and that the discounts have been substantial. Likewise, I am told that appraisers are increasingly being asked by lenders to do whatever possible to appraise the properties relative to current market conditions and to discount price information from the historical comparables. My contacts are also saying that the expectation that home prices are going to fall further has been keeping some buyers on the sidelines for now. I also hear that, when possible, residential contractors are shifting resources to nonresidential projects. Some nationally publicly traded home construction companies are completing houses and selling them for a loss in some markets just so that they can exit those markets more quickly. What I take away from my conversations with homebuilders and lenders is that the national data may not yet fully have caught up with the poor conditions in the residential construction sector and, further, those closest to the markets are betting that any semblance of a recovery is still a long way off. This information had an influence on the economic projections that I submitted for today’s meeting. Like the Greenbook, which as a consequence of more weakness in residential construction has shaved an additional 0.5 percentage point off GDP growth in the latter half of this year, I have marked down my expectations for growth in 2007. My projection sees a little more growth relative to what I see in the Greenbook as we move into 2008 and 2009, although I do see slower economic growth as an obvious risk to my outlook. I’m especially concerned about the possibility of some spillover from the housing sector to the business investment outlook. My inflation projection calls for a slightly more optimistic trend in core PCE than what I see in the Greenbook. I had difficulty endorsing a three-year projection that doesn’t assume that our policies are going to be positioned so that we eventually bring core PCE inflation back below 2 percent, if only just below. So my inflation projection represents my interpretation of appropriate monetary policy—namely one that will bring core PCE in under 2 percent. My economic projection is, therefore, based on a federal funds rate path that is very similar to the Greenbook baseline, a constant path over the projection period; but I have assumed a slightly more optimistic price path for oil. Given Karen’s comments this morning, I am a little more comfortable with that assumption. I also have slightly more potential than the Greenbook does. So with these two assumptions, I do have a slightly lower path for inflation than the Greenbook does. Obviously, these assumptions are not made with great conviction, and inflation may continue to track just north of 2 percent. If it does, we do risk conditioning expectations to this level, and that is an outcome that I would not welcome. I had an opportunity just a few weeks ago to spend a day with Paul Volcker, who visited Cleveland. On the subject of inflation, he reminded me that in his experience big inflations start out as a tolerance of modest inflations. Once inflation expectations drag their anchor a little, it’s difficult and costly to get them re-anchored; and this, I think, remains the biggest risk that we face as a Committee. Thank you, Mr. Chairman." FinancialCrisisReport--262 Subprime loans, Alt A mortgages that required little or no documentation, and home equity loans all posed a greater risk of default than traditional 30-year, fixed rate mortgages. By 2006, the combined market share of these higher risk home loans totaled nearly 50% of all mortgage originations. 1014 At the same time housing prices and high risk loans were increasing, the National Association of Realtors’ housing affordability index showed that, by 2006, housing had become less affordable than at any point in the previous 20 years, as presented in the graph below. 1015 The “affordability index” measures how easy it is for a typical family to afford a typical mortgage. Higher numbers mean that homes are more affordable, while lower numbers mean that homes are generally less affordable. By the end of 2006, the concentration of higher risk loans for less affordable homes had set the stage for an unprecedented number of credit rating downgrades on mortgage related securities. 1013 3/2009 U.S. Department of Housing and Urban Development Interim Report to Congress, “Root Causes of the Foreclosure Crisis,” at 8. 1014 Id. 1015 11/7/2007 “Would a Housing Crash Cause a Recession?” report prepared by the Congressional Research Service, at 3-4. (2) Mass Downgrades fcic_final_report_full--400 THE ECONOMIC FALLOUT CONTENTS Households : “I’m not eating. I’m not sleeping” ..................................................  Businesses: “Squirrels storing nuts” ...................................................................  Commercial real estate: “Nothing’s moving” ......................................................  Government: “States struggled to close shortfalls” .............................................  The financial sector: “Almost triple the level of three years earlier” ....................  Panic and uncertainty in the financial system plunged the nation into the longest and deepest recession in generations. The credit squeeze in financial markets cascaded throughout the economy. In testifying to the Commission, Bank of America CEO Brian Moynihan described the impact of the financial crisis on the economy: “Over the course of the crisis, we, as an industry, caused a lot of damage. Never has it been clearer how poor business judgments we have made have affected Main Street.”  In- deed, Main Street felt the tremors as the upheaval in the financial system rumbled through the U.S. economy. Seventeen trillion dollars in household wealth evaporated within  months, and reported unemployment hit . at its peak in October . As the housing bubble deflated, families that had counted on rising housing val- ues for cash and retirement security became anchored to mortgages that exceeded the declining value of their homes. They ratcheted back on spending, cumulatively putting the brakes on economic growth—the classic “paradox of thrift,” described al- most a century ago by John Maynard Keynes. In the aftermath of the panic, when credit was severely tightened, if not frozen, for financial institutions, companies found that cheap and easy credit was gone for them, too. It was tougher to borrow to meet payrolls and to expand inventories; businesses that had neither credit nor customers trimmed costs and laid off employees. Still to- day, credit availability is tighter than it was before the crisis. Without jobs, people could no longer afford their house payments. Yet even if moving could improve their job prospects, they were stuck with houses they could not sell. Millions of families entered foreclosure and millions more fell behind on their mortgage payments. Others simply walked away from their devalued proper- ties, returning the keys to the banks—an action that would destroy families’ credit for  years. The surge in foreclosed and abandoned properties dragged home prices down still more, depressing the value of surrounding real estate in neighborhoods across the country. Even those who stayed current on their mortgages found themselves whirled into the storm. CHRG-110hhrg34673--227 Mr. Bernanke," It is a bit early to tell. We saw a big spike in bankruptcy filings in advance of the law because people, if they were thinking of going bankrupt, they wanted to get that done before the law change. Since then we have seen a moderate rate of bankruptcy, I think somewhat lower than in the past, but whether that is due to the change in the law or just to generally good financial conditions in the last few years is hard to say. Again, we have seen, for example, very few delinquencies in consumer credit or in mortgages outside the subprime market, so there has been a generally good credit situation in the last couple of years, and that seems to be reflected in a relatively low rate of bankruptcies. " CHRG-110shrg50369--112 Mr. Bernanke," Well, if higher inflation were to become well embedded in inflation expectations and wages and other parts of the economy, it would be difficult, and we do not really have new methods. It is a risk, and we take it very seriously, and we are monitoring it very closely. But as I have said several times, we are dealing with a number of different concerns here, and we are trying---- Senator Schumer. I know. It is not easy. " Mr. Bernanke," ----the risks as best we can. Senator Schumer. Thank you, Mr. Chairman, and I thank my colleagues. " CHRG-111hhrg48874--59 Mr. Long," I will take a shot at it, Congressman. And they are concerns that we hear too. There are a couple of things. In terms of, do we think it's going to get worse? I would tell you, from the OCC's standpoint, where we are in the cycle, I believe for many community banks, it is going to get worse. So we are definitely asking our examiners to have good communications with bank management and make sure that they're vigilant, make sure that they have a good handle around the concentrations of credit, the amount of loans that they have to a certain--whether it be industry, developer or whatever. It may be that being told to slow down could be appropriate, but I would need some more information to address it specifically. It may be that the banker or the regulators feel like that concentration level in total on that balance sheet is getting a little heavy and they need to be a little more selective in terms of the risk. It may be in terms of their underwriting, given the credit quality of the borrowers and the stress that the borrowers are under, as you know, Congressman, over the last 3, 4, or 5 years underwriting standards got pretty loose. It was pretty easy to extend credit, and it wasn't that difficult to get a loan. What is happening in the industry right now is a normal occurrence. Bankers tighten up, underwriting standards tighten. Loan demand by good quality borrowers--as I said in my statement, businesses aren't expanding, they don't have capital expenditures--good quality loan demand is harder to come by. But the examiners and the bankers hopefully are having good robust conversations around risk management issues, concentration issues, underwriting issues, whether it be from an individual loan or from a portfolio loan. So the comments along those lines could very well be not: Slow down, we don't want you making good loans. It may be: Make sure you have a good handle around the risk profile of your portfolio, because certain concentration levels, no matter how good they get, when you get into an economic downturn, it doesn't take much to tip a bank over. " CHRG-110shrg50414--76 Secretary Paulson," The answer is yes, and it is very easy to rationalize it to the American people. Senator Shelby. I need your help here. " Secretary Paulson," OK. Here is how I want to--this is all about the American taxpayer. That is all we care about. And so any business, any banking operation in the United States that is doing business here and dealing with the American public is important. They are all important to keeping our markets open, keeping credit flowing. The American public, when they are dealing with the financial system, does not know who owns that bank. What they care about is how is the system working. And so we are doing this to protect the system, and it is about keeping credit flowing, protecting savings, making it possible to have car loans, student loans, mortgages. And, again, if you have operations in the United States and you are doing business with the American people, that is what we are focused on. But let me also say to you we have a global financial system, and when I was on the phone a number of times, and most recently Monday morning, talking with central bankers and finance ministers around the world, I urged them all to put in place where it is necessary similar programs with similar objectives. Senator Shelby. What do you say to people that ask us, or at least ask me--and I am sure others--how do you rationalize or justify bailing out banks and so forth that cause, are the root cause of a lot of this problem where they will be made whole with capital, at least it will strengthen them? And I understand that strengthens the economy, but they will profit dearly from this, more than likely. " CHRG-111shrg57320--387 Mr. Corston," Well, policy is not my area of expertise, but I will say this: As an examiner in an institution, a tool such as a regulation is fairly easy to support. Guidance becomes--you can support it, but it is not as strong. Because it goes more to best practices, again, it becomes more something you need to influence. So it is something that, certainly from a rules standpoint, obviously needs to be looked at. From an examiner's standpoint, it is a challenge. Senator Levin. You had an acceptable structure at WaMu, as you said. " CHRG-111shrg53176--86 Mr. Levitt," With respect to say on pay, what I would say about this, this sounds like an easy call. How can you be against it? And I am not. But I think it is simplistic. It can be a check the box kind of mentality, which businesses can easily incorporate and just move on. I urge any legislation to allocate to the SEC the responsibility of defining exactly what that means under what circumstances, how it is done, how far down it goes, what the details should be, what the explanation should be, what the history should be. Not simply pass a rule because, I assure you, it looks differently than if you refine it in a way that I think the Commission should be charged with doing. " FOMC20061212meeting--49 47,MR. STOCKTON.," Well, it is in the forecast. It’s just not so easy to see on a revision-by- revision basis because we’re also being surprised by the tightness of the overall labor market, by the decline of the dollar, and by somewhat higher import prices. So there have been other offsetting factors that are masking the underlying effect of the lower energy prices. We have built in those energy prices on the upside; we’re taking them out on the downside; and they are, I think, an important factor behind the contour that we’re projecting. It’s just that there are other factors operating." FOMC20050630meeting--25 23,MR. GALLIN.," Okay. I can tell something from the tone of your voice. [Laughter] In any event, the idea there was to look at house prices and construction costs and to try to back out as a sort of mechanical operation—not an easy one—the value of the land. He shows that land prices have increased very rapidly and that the land share of the property values has gone up over time. As you mentioned, we know something about farm prices. But besides those two things, there really aren’t—" CHRG-110shrg50414--92 Secretary Paulson," I wish it were that simple because--and even that would not be easy. But what the Chairman said, when he presented, he said no one has been faced with this situation before. We spent a lot of time thinking about it, and there are different types of asset classes--mortgage derivatives, mortgage-backed securities. There are different whole loans. And so when you look at dealing with this, we are going to have to use different approaches in different situations, and there will be market-based approaches, and that is all--even I cannot sit here and figure out what the auction technique should be and how to use it and in what situations to use it. So what we asked for was broad-based authority to use a series of market-based approaches, and we will be dealing in different approaches in different situations. We cannot sit here and say here is the reverse auction we are going to use in every situation. So we need flexibility. Senator Bennett. My time is up. I understand that. My time is up. I just wanted to leave this last comment. This is the whole core of what you are trying to accomplish, and this is the whole problem with our giving you blank-check authority to accomplish it, because in theory it is easy to describe and it will work, but if you end up paying too little to these institutions, which mark-to-market accounting might drive you to, you are not giving them the support that they need. If you end up paying too much, then there is no upside potential for the taxpayer when the time comes for you to liquidate these, and the details of how you find the right balance here are the ones that all of us need--you, but certainly as much as we--all of us need to understand better as we make our determination whether or not to support your proposal. " FOMC20080130meeting--208 206,CHAIRMAN BERNANKE.," Thank you, and thank you all for succinct and very insightful comments. [Laughter] I'm going to try as usual to summarize what I've heard; but even more so than usual, no warranty is expressed or implied. Again, trying to bring together some of the comments, we noted that incoming data since the last meeting have been broadly weaker than expected, and anecdotes generally suggest slower growth, in some cases significantly slower growth. Housing demand, construction, and prices have continued to weaken, and inventories of unsold homes are little changed. Housing weakness has implications for employment, consumer spending, and credit conditions. With respect to households, consumption growth has slowed, reflecting falling house and equity prices and other factors, including generally greater pessimism about the labor market and economic prospects. The labor market has softened by a range of measures, with unemployment jumping in December. However, workers in some occupations remain in short supply. Together with financial indicators, weaker labor and consumption data suggest that the economy is at a risk of recession; in any case, it is likely to grow slowly for the first half of the year. The second half of the year may be better, the result of easier monetary policy, fiscal stimulus, and possible improvement in housing and credit markets. However, there are significant downside risks to growth, including the possibility of an adverse feedback loop between the economy and credit markets. Reports by firms are mixed. Investment may have slowed, reflecting uncertainty and slower growth in demand. Commercial real estate activity may be constrained by tighter credit conditions. Manufacturing is slow to mixed, though IT, energy, and some other sectors continue to be strong. Financial markets remain stressed. Credit conditions more generally appear to be worsening, and the problems may be spreading beyond housing. Additional risks are posed by the problems of the monoline insurers. Credit losses have induced tighter lending standards, and a key question is how severe those may become and how persistent they may be. One offset is the ability of banks to raise capital. Core inflation and headline inflation have remained stubbornly high and are a concern. One risk is the ability of some firms to pass through higher input costs. Inflation compensation has risen at long horizons, reflecting some combination of higher inflation expectations and inflation risk premiums. Going forward, a slowing economy, anchored inflation expectations, and possibly stabilizing food and energy prices should lead to more moderate core and total inflation. However, some see upside risks, especially the possibility that higher headline inflation might affect inflation expectations. So that's my attempt to summarize. There's a great deal more detail and a great deal more color in the conversations around the table. Let me try to add a few points. Again, much of what I'll say has been said. I do think that there has been a significant deterioration in the outlook for economic growth and an increase in the downside risks to growth. It was sufficiently severe as to prompt me to call the January 9 videoconference that we had, and I think that since then we have had further deterioration. A number of things have happened and are going on. Very important, perhaps most important, is the continued further deterioration in the prospects for the housing market. Housing, of course, feeds directly into the real economy through employment, income, and wealth, and I think there are some indications that spillover from the housing sector to the rest of the economy is increasing. However, the critical aspect of the housing outlook is the relationship to the financial system, which I'll come back to. Consumer spending has slowed. I think there's little doubt about that at this point. There are a lot of factors now that are acting as headwinds in the consumer sector. Let me just point out the basic fact that most households in the United States have very little in the way of liquid financial assets. Therefore, when they, on the one hand, are denied access to home equity if they see tighter credit conditions on cards, autos, and so on, and if at the same time they see greater uncertainty in the economy and the labor market, then their natural tendency would be to be much more conservative in their spending. I do note that fiscal action may be of some help, particularly for people in that kind of situation. Like President Yellen, I think the indicators of a weakening labor market are broader than just the payroll report. There are a number of other things as well. We may get a better report this week. The UI claims are a little encouraging, but I do think that the weakening economy is going to drag down the labor market to some extent. Certainly the financial markets have deteriorated, reflecting greater concern about recession. We see it in the equity markets but also in short-term interest rates and a variety of credit measures as well. Finally, just going through this list of items, we continue to see problems--credit issues, banks concerned about additional losses not just in mortgages but perhaps in other areas as well--with the potential implication of a further tightening of credit conditions. Those are some of the developments that we've seen since the last meeting. On our January 9 call, I talked about the regime-switch model and those ways of thinking about the business cycle. Others have talked about that today. I think many of those models would suggest that the probability of recession at this point is quite high, at least 50 percent or more. I don't think any of us would be happy to see a garden variety NBER recession; but if we had that, there would probably be a few benefits, including correction of some imbalances that we're seeing in the economy and perhaps some reduction at the edge in the inflation picture. But, like others, I am most concerned about what has been called the adverse feedback loop--the interaction between a slowing economy and the credit markets. A phrase you might have heard, which is getting great currency among bankers, is ""jingle mail."" Jingle mail is what happens when otherwise prime borrowers decide that the value of their house is worth so much less than the principal of their mortgage that they just mail their keys to the bank. (I wonder if that 140 percent is the right loan-tovalue number. Maybe it's less than that.) Even if prime mortgages hold up--and I think in some regions of the country there will be significant problems with prime mortgages--there is a lot of other potential trouble. We're just beginning to enter the period of maximum subprime ARM resets. Second lien piggybacks and home equity loans are all questionable at this point. We haven't begun to address the option ARM issue, which is about the same size as the subprime ARM category, and of course, we have the issues with the monolines and private mortgage insurers. Outside of mortgages, expectations for credit performance are worsening in a range of areas, including commercial real estate and corporate credit. So I think that even under the relatively benign scenario that the Greenbook foresees, we're going to see a lot of pressure in the credit markets and perhaps a long period of balance sheet repair, tight credit, and a drag on the economy. Again, our experience with financial drag or headwinds has been that it can be quite powerful and deceptively so, and I think that's a significant concern. Now, the central issue here, though, ultimately comes back to the housing market. Certainly by this point there must be some pent-up demand for housing. We've had obviously very low sales for a period. House prices are soft. Mortgage rates are low. Affordability is better. What's keeping people from buying houses is the fact that other people aren't buying houses. If there were some sense that a bottom was forming in the market or in house prices, we probably could actually see a pretty quick snap-back, an increase in housing demand, and that in turn would feed back into the credit markets, I think, in a very beneficial way. So there's the possibility that, if the housing market can get restarted, we could get a relatively benign outcome. " FOMC20081029meeting--263 261,CHAIRMAN BERNANKE.," Okay. Thank you. Let me try to summarize all that I heard today and yesterday, and then I'll try to add some new comments to that. The outlook for economic growth appears to have deteriorated quite significantly since the last meeting. Data on consumer spending, production, and employment had weakened more than expected even before the recent intensification of the financial crisis. Over the past six weeks or so, however, financial conditions have greatly worsened, and risk aversion has increased, despite actions here and abroad to stabilize the banking system. Equity values have declined sharply amid conditions of low liquidity and extraordinary volatility. Credit market conditions have improved modestly since the global actions to recapitalize banks and guarantee their deposits, assisted also by additional central bank liquidity actions. However, in almost all credit markets, spreads remain much wider, maturities shorter, and availability more constrained than was the case before the intensification of the crisis. Firms face continued funding risk and rollover risk. Banks have probably not reserved sufficiently for the credit losses to come, and hedge funds will be hitting their net asset value triggers in greater numbers, forcing them to liquidate assets. The duration of future financial turmoil is hard to judge, but it could be lengthy. The worst thing is that financial conditions appear already to have had a significant and remarkably quick effect on activity and consumer and business expectations and plans. Most Committee participants see us in or entering a recession and have marked down significantly their expectations for near-term growth or for the pace of the recovery. The difficulty of predicting the course of the crisis or its effects on the economy has also increased forecast uncertainty. In particular, the ultimate effects of some major policy actions, such as the creation of the TARP and the bank guarantee, are not yet known. Uncertainty about future policy actions, as well as uncertainty about the economy, has affected behavior in markets and the broader economy. Consumer spending has weakened considerably and probably fell sharply in the third quarter, reflecting in part a recessionary psychology. Consumer durables, such as automobiles and discretionary expenditures, have been particularly hard hit. This weakness reflects the same set of negative influences on consumption that we have been seeing for a while, now compounded by losses of equity wealth and confidence effects on prices, although lower oil prices may provide some relief. The labor market continues to decline, with many firms reporting that they are cutting back workers. The housing sector has not been noticeably worse than expected, and reports are somewhat mixed. But on a national basis, the contraction is continuing, and recent developments in the economy and credit markets are likely to have adverse effects. Inventories of unsold new homes remain high, putting pressure on prices. Nonresidential construction continues at a moderate pace; but backlogs are falling, and the sector is looking increasingly vulnerable to weakening fundamentals and tighter credit conditions. Whether a new fiscal stimulus package will be passed and to what extent such a package would be helpful remain open questions. Manufacturing production has weakened significantly as have expectations of demand, including export demand. Credit is becoming more of a problem for many firms and their customers. Spending on equipment and software appears to have slowed, reflecting greater pessimism and uncertainty. Falling commodity prices may reduce mining activity and cool the boom in agriculture. On the plus side, firms are reporting fewer cost pressures, and inventories do not appear excessive. Deterioration in global growth expectations has been marked. Industrial economies had already shown signs of slowing, and they have been hit hard by recent financial developments. Emerging market economies, until recently evidently not much affected by the U.S. slowdown, have in recent weeks also been hit hard by the spreading financial crisis. Together with the stronger dollar, these developments are likely to restrain future growth of U.S. exports. Inflation risks have declined materially, reflecting the fall in the prices of energy and other commodities, the stronger dollar, and the prospect of considerable economic slack. Firms report much reduced pricing power and lower markups. Inflation expectations have come down, both in the surveys and in the TIPS market, though it wasn't noted--but I will note--that the TIPS market is distorted by illiquidity and other problems there. Most participants see both overall and core inflation moderating in the coming quarters toward levels consistent with price stability, with some seeing a risk of undesirably low rates of inflation. Some note, however, that financial dislocations affect aggregate supply as well as aggregate demand and may reduce the extent to which slower growth damps inflation. So that's just my sense. Any comments? Additions? Let me make just a few additional comments, none of which will be radically different from what we have already discussed. I do think it is overwhelmingly clear that we are now in a recession and that it is going to be a severe one. To give some sense of perspective, the postwar record for duration is 16 months. If the NBER sets this experience as having begun early this year, I think we have a reasonable chance to break that record. The largest increase from peak to trough in unemployment rate was in 1981. It was 3.6 percentage points. Starting from 4.4 percent, I think we have a chance to come close to that number. Yesterday's drop in consumer confidence in one month from 61 to 38 shattered the previous low of 43 in December 1975. So I think we are talking about an episode here that could easily be among the largest postwar recessions. We don't know how things would have evolved without the developments in September, but obviously we have to deal with that reality. It was just a few weeks ago that we were dealing with what might have been a true systemic crisis, in the week leading up to the G-7 and IMF meeting. I think it has been very fortunate that Europe, the United States, and other countries have adopted vigorous responses to that, including bank capitalization, bank guarantees, and other measures. That has been very important in calming the situation somewhat and reducing the systemic aspects of investor concerns. That being said, concern about counterparties remains very strong. Risk aversion is intense, spreads remain high, and I think that this has now become really pervasive. It isn't just a question of junk bonds and weak borrowers or weak credit histories. The spreads on GSE debt, on high-grade corporate debt, and other areas have also widened, leading to a very broad based tightening in credit conditions. So I think that, overall, any reasonable reading of financial conditions suggests that the tightening of credit or financial conditions in the last six weeks or so has been quite substantial and overwhelms the effects of our coordinated rate cut. Now, normally you would expect to see a tightening of credit conditions affect the economy with some lag. It takes time for people to borrow money and to use the money they borrow to make expenditures. But compared with that prediction, we have instead seen a sudden stop--a remarkable and very rapid effect on economic activity. It is possible this is due less to the direct effects of credit availability and more to the psychological impact of these events. One possible analogy is the 1980 Carter credit controls, when the government announced what seemed to be a tightening of credit. There was a very sharp response in economic activity, probably based more on expectations than on actual credit availability. Unfortunately, the credit controls could be removed by government fiat; we are not able to do that today. One interesting development is that the labor market has not yet shown as much weakness as one would expect. Unemployment insurance claims and other indicators do not yet show a marked deterioration. I expect that we will see more deterioration of the labor market. Besides the intensification of the financial crisis that has markedly increased the restrictiveness of financial conditions, I think the other very important development since our last meeting has been the internationalization of the crisis. We had already seen weakening in Europe before the most recent intensification, but it has become much more severe. There is little doubt that the United Kingdom and Europe are in or about to enter recession. My sense is that their monetary policy responses will be stronger than what the Greenbook anticipates. I believe they will be very aggressive in responding to that. A new and particularly worrying development is the fact that the crisis has now spread beyond the industrial countries to the emerging markets. The G-7 weekend was quite an interesting one. It was a striking experience. I heard over and over again from the Indians, from the Brazilians, and from all over the world that, until the middle of September we were fine, we were not being much affected, we didn't see much effect on our trade flows, and suddenly everything changed; and now we are under severe stress. We are seeing tremendous outflows. Our currencies are plummeting. Commodity price declines are hurting many countries. I think that is going to be a very significant development as we go forward. Just to give some data, in just a few weeks the EMBI spread, the emerging market sovereign debt spread, went from 280 basis points to 850 basis points; and the emerging market equity index has fallen about 40 percent since the last meeting. It is not obvious that these changes were justified by economic fundamentals. Many of these countries are very well run and had shown a lot of progress in their domestic policies and their domestic economies. Instead, I think they are suffering contagion from us mostly. Unfortunately, the implications of this will be not only the usual trade and commodity price type of implications but also, and even more important, financial implications. We are now seeing that the adverse feedback loop, which we've been talking about for a long time in the United States, is becoming a global phenomenon. In particular, European banks are very heavily exposed to emerging market debt. So we are going to see yet more of this interaction between the financial markets and the broader economy, except at a global rather than a national level. These developments, obviously, are very disturbing and don't bode well for U.S. growth or now for global growth. Somewhat ironically, all of this deterioration in the global outlook has led the dollar to appreciate very sharply, which is interesting to say the least. For us that obviously also has important implications for inflation, and as Governor Kohn mentioned, it means that we will be less a recipient of foreign strength and more a supporter of foreign weakness than we have been until now. On inflation, I know there is some discomfort in talking about a 1 percent policy rate and promising to keep it low for a protracted period--and all those things. We have seen this movie before, and I think we all have to recognize the importance of watching the implications of that for our economy and for asset prices and to take quite seriously the responsibility for removing accommodation in a timely fashion once the crisis has begun to moderate. That being said, I don't think that there is really any case in the near term to be worrying very much about inflation--or, perhaps even less so, the dollar--as we look at our policy. Pricing power is evaporating. And given what is happening in the global economy, I don't see a commodity price boom any time soon, although I think as the economies do begin to recover in the next year or so that we might see some recovery in commodity prices. So I think that, as everyone has indicated, this is a very worrisome situation. I don't think we have control of it. I don't think we know what the bottom is, so we have to remain very flexible and very open to new initiatives as they become necessary. There has been some comparison of this to the Japanese situation. I'm beginning to wonder if that might not be a good outcome. The advantage of the Japanese was, first of all, that they were isolated. The rest of the world was doing okay, and they were able to draw strength from their exports and the rest of the global economy. Although they had very slow growth, they never really had a deep recession or big increases in unemployment. I think we are looking at perhaps a much sharper episode, and our challenge will be to make sure that it doesn't persist longer. I do think that one lesson of both Japan and the 1930s as well as other experiences is that passivity is not a good answer. We do have to continue to be aggressive. We have to continue to look for solutions. Some of them are not going to work. Some of them are going to add to uncertainty. I recognize that critique. I realize it's a valid critique. But I don't think that this is going to be a self-correcting thing anytime soon. I think we are going to have to continue to provide support of all kinds to the economy. Let me stop there and, unless there is any question or comment, ask Brian to introduce the policy round. " FOMC20080130meeting--207 205,MR. MISHKIN.," By the way, if you know my wife, no it wasn't close. The second issue is that the potential for weaker house prices, which really is a significant possibility, not only could lead to lower household wealth but, more important, also could reduce the value of collateral for households and as a result mean that the relaxation of credit constraints that collateral affords is no longer there. That could have major implications in terms of household spending, so it is also a very substantial downside risk to PCE. The third issue is that we also see that the financial disruption has already gotten worse. The good news is that there has been improvement on the liquidity front, and I give a lot of credit to the TAF, which was superbly thought out by our staff and has been quite helpful. However, credit conditions have worsened. Particularly worrisome--and something that hasn't been discussed much--is that the Senior Loan Officer Opinion Survey had substantial tightening. Usually when you see this kind of tightening, it could indicate that we could have serious negative economic consequences. Again, that actually makes me very nervous. Finally, to get even more depressed, there really is potential for a negative feedback loop that has not yet set in. The financial disruption that we're seeing right now could then mean a more substantial worsening of the aggregate economy, and that could make the financial markets have even more strain, and you have a problem. So I really worry about the downside risks and think that they are very substantial and that we should be very concerned about them in thinking about what the appropriate policy stance is. On the issue of inflation, I'm more sanguine. I see inflation going down to 2 percent by 2009. The key here is that I think that inflation expectations are grounded--in fact, are grounded at a level that is consistent with my inflation objective, around 2 percent on PCE, which might be different from others' views, but that's where I am right now. In that context, given that inflation expectations plus expectations about future slack in the economy are the primary drivers of inflation dynamics, I actually think that inflation will come down. It is true that the recent inflation numbers have been very bad; but in thinking about the overall risks, I'm a bit different from the average person on this Committee because I think the risks are balanced and actually somewhat to the downside. The reason I say this is that I think that inflation expectations are grounded. At the same time, there is a substantial downside risk in the economy that could really widen slack in the economy, and that would mean that inflation would come down. I don't want to be too sanguine on the issue of inflation expectations being grounded. In fact, one thing that I think we have to monitor very closely is what's happening in terms of inflation expectations, particularly financial markets' views of inflation expectations. In a sense, I think of that as the canary in the coal mine. We are also going to want to look at expectations spreading to professional forecasters and to households, but I think information would come in first in terms of the financial markets for the reason that they put their money on the table and react quickly. That's one reason I think it's very important to look at things like inflation compensation. But we do need to look at this and do the analysis. My reading of the analysis that the staff gave and my thinking about the issue is that there is just no evidence that inflation expectations have gone up. The story is extremely hard to tell to go in that direction. However, it is very easy to tell a story that inflation uncertainty has gone up a lot, and this is something that President Evans talked about and we talked about at the very beginning of a long day. In this context, that does concern me, and it really tells me that we have to think about whether we can better anchor inflation expectations. So I think that this is something that we have to be concerned about, but I do not think that what has happened in inflation compensation is that the canary is dropping dead at this stage. But we do have to monitor this very, very closely, and again, it's part of the risk-management strategy that I think we have to pursue. Thank you, Mr. Chairman. " CHRG-109shrg21981--134 Chairman Greenspan," I would say that whatever it is we do in the short-run, unless we start getting serious about the longer-run problems, I think we are going to run into them and be poorly positioned to effectively handle them without very significant problems. Senator Bayh. At some point when you feel comfortable, in some forum, it really would help us to try and have some benchmarks of performance against which we can judge all of ourselves, both sides of the aisle, all branches of Government. As you know, it is easy to talk about these things. It is a lot more difficult to implement them and then hold ourselves to some kind of standard. " CHRG-111shrg62643--110 Mr. Bernanke," I would much prefer to see consolidation or cuts over the medium term as opposed to immediately. Senator Tester. Let me get to that, because we all know that large and unsustainable deficits, as you have pointed out in the past, ultimately, we are going to have to make some tough decisions. Ultimately, we are going to have to make some choices, none of which will be easy, whether you are talking about cutting expenditures or increasing the income. What are the indicators that you would use to determine when we start addressing those issues, and is today the day we start or when do we start? " CHRG-110hhrg46596--260 Mr. Kashkari," It is a very important issue. And I don't think there is a perfect brightline test that anybody can apply. But ultimately, each of these mergers and acquisitions needs to be approved by their primary Federal regulator, in many cases of both the target bank and the acquiring bank. And the regulators who are there onsite are in the best position to judge is this a prudent acquisition or is this a risky acquisition. Treasury, as you know, is not a bank regulator. But they don't have an easy job either. " CHRG-110shrg50414--60 Mr. Bernanke," Mr. Chairman, the financial markets are in quite fragile condition, and I think, absent a plan, they will certainly get worse. But even in the current state, they are not serving the necessary function to support the economy. Credit is not being provided. As Secretary Paulson mentioned, non-financial companies are not able to finance themselves overnight. Credit is just not going to be available. It is going to also affect savers because of the values of their assets that they have. So even in the current condition, even if things do not get severely worse--but I think they would get worse without some kind of action--this will be a major drag on the U.S. economy and will greatly impede the ability of the economy to recover in a healthy way. The amounts involved are intended to be enough. We do not want to go in and underwhelm the situation. That might be to suggest more problems down the road. There have been some ways of looking at it. This is about 5 percent of all the mortgages outstanding, for example, $700 billion. But it certainly illustrates the size of these markets and the size of the problem. I think it is important to state that, as I mentioned before, this is not an expenditure of $700 billion. This is a purchase of assets, and if auctions are done properly, if the valuations are done properly, the American taxpayer will get a good value for his or her money. And as the economy recovers, most all or perhaps more than all of the value will be recovered over time, as was the case in other similar situations in the past. " CHRG-110hhrg46595--126 Mr. Manzullo," Thank you, Mr. Chairman. I am quite distressed over the continuous talk coming from the Big Three that there is no money available for consumers to buy your automobiles. Credit unions, local branches of national banks, and community banks are loaded with money and are ready, willing, and eager to give to people to buy your automobiles. On the current business environment on the Ford, page 3, quoting the Federal Reserve's senior loan officers, it says, ``Over 60 percent of banks have tightened standards for consumer credit.'' That is not the case. I talked to a bank yesterday. I said, ``Have you changed any standards in the past year?'' He said, ``No.'' He said what happened is the Big Three set up their own financing arm and they pushed the community banks out of lending. And then you come back here, and you have created much of the crisis among yourselves because you created your own subprime market in automobile loans that is sitting out there because it was too easy credit to people who couldn't afford to buy the automobiles that you sold to them. That originally is what TARP was set up for was to buy that back. And now, Mr. Wagoner, you want to go into the commercial banking business. You want to be able to take demand deposits or set up checking accounts. I mean, you would be a bank on the order of Wal-Mart, which we stopped, and Mr. Nardelli, of Home Depot, which we also stopped. Why would an automobile manufacturer go into the commercial banking business and wreak havoc on the community banks, credit unions, and local branches of national banks? You are there to make cars, not to run a banking operation. That is part of the bailout, so that you can become a commercial bank? I don't expect an answer because there is no good answer to that. Your job is to make cars. And the other thing is I noticed that both Ford and GM have overseas subsidiaries that are doing quite well. My question to each of you is, have you taken advantage of the IRS 60-day window to bring back profits from overseas operations to infuse them into your domestic operation without having to pay 35 percent tax? Mr. Wagoner, have you done that? " FOMC20071211meeting--118 116,CHAIRMAN BERNANKE.," Thank you, Governor. Well, again, thank you for a very helpful discussion. Let me just try to briefly summarize and then offer a few additional comments. Many participants obviously gave considerable attention to the resurgence of stresses in financial markets, including the increased losses by financial institutions, widening spreads, and poorly functioning markets. Some expressed concern that these developments were likely to result in tighter credit—not just in mortgages, where conditions are already tight, but in other areas as well— perhaps resulting in spillovers to the broader economy. A weakening economy could cause financial conditions to worsen further, leading to a negative feedback loop, and indeed, there are signs of some broader credit deterioration. Impending mortgage rate resets and foreclosures pose further risks. Some took these developments as increasing downside risk to growth, perhaps significantly. However, other participants noted some mitigating factors, including the fact that banks came into the situation with a lot of capital. Some institutions have raised capital. There’s the possibility that other credit providers could take over from money center banks. Corporate balance sheets are strong. The credit problems have a regional focus in some cases, and there is a lack of effect so far on many on Main Street. Some also noted that the price discovery process was inevitable and needed. With respect to the macroeconomic data, overall the incoming data were slightly weaker than expected, particularly in housing and consumption, although, again, the anecdotes were somewhat mixed. Fundamentals for consumption are weaker but not collapsing, with the labor market and perhaps wealth still providing some support and mixed information on retail sales. Differences across regions and products were noted. With the possible exception of commercial real estate in some cases, investment is not yet much affected by credit conditions. Improvements in inventory management were cited as a positive. Unemployment remains low, and wage pressures exist in some areas, but they were less cited, I think it’s fair to say, than in past meetings. Export demand related to the weaker dollar and strong foreign growth provides some help to the manufacturing sector, although it was noted that other countries might not be immune to a slowdown in U.S. growth. Overall, most participants saw slower growth, but there is greater agreement that the outlook is in any case more uncertain. On inflation, some took a relatively benign view noting the restraint from a slowing economy and less tightness in labor markets. Others noted some recent increases in core inflation and continuing pressures from energy, food, and the dollar. Many stressed that stable inflation expectations cannot be taken as a given. Any comments or questions? Let me just add a bit to the discussion because, as usual, it has already been very thorough. Again, if one looks at the incoming macro data, I think a fair judgment is that it was a little weaker than we expected. The economy has been a little slower than we expected. Housing data, consumption, and I would argue investment and production numbers were all somewhat lower than we thought was going to be the case at the end of October. I would also argue that, in particular, the consumer, who of course is crucial to the expansion, is facing somewhat weaker conditions— including higher oil prices, less wealth from lower stock and house prices, and perhaps tighter credit—than was the case a month and a half ago. I think it is noteworthy that the unexplained portion of consumer sentiment has declined considerably. There seem to be attitudes or, if you like, forecasts among consumers that are even weaker than would be suggested by some of the conditions they are currently seeing, and I think that is a concern. Now, there have certainly been positive developments in the data. The labor market has held up pretty well. The unemployment rate actually dropped a bit last week. Stocks have come back a bit from their so-called correction, although I should say that this is conditional on a lot of expected easing by the Federal Reserve. ISM surveys show manufacturing as flat, but manufacturing is still growing, and there was a bit of good news yesterday in housing, with some slight indications of improved pending sales. I think it’s interesting that the Michigan survey notes that prospective homebuyers are actually a bit upbeat because they see interest rates as low and prices as more favorable. So, again, the data suggest some weakness, but the story is not entirely unmixed. So how would we interpret this? I think you could take a more sanguine view that we are seeing the continuation of a zigzag pattern that we’ve seen for quite a while. We had very weak growth in the first quarter of this year, for example; but even with the zero growth projected for the fourth quarter, we will see 2.2 percent growth in the first half of ’07 and 2.5 percent growth in the second half of ’07. So it could be that we’re just seeing a zigzag pattern, and some of that is certainly true. It’s also still true that a lot of the weakness we’re seeing is in the housing sector. For example, for all of ’07, growth excluding housing is about 3½ percent—so again, not suggestive of great weakness. Now, all of that being noted, I don’t think I’d go quite as far as Governor Mishkin; I try to maintain an even keel here in my mood. [Laughter]" FOMC20080805meeting--89 87,MR. LOCKHART.," I just want to point out that we hear a fair amount of anecdotal feedback suggesting that just determining what is the net real price for a house is not so easy because of incentives, particularly in multifamily but also new homes in general. You pay list, but you get a Mercedes and a year's worth of gasoline and your lawn mowed and a lot of things thrown in for the seller to hold the price close to what the list is. So I don't know how these things are actually measured to take into account those kinds of incentives. " FOMC20080724confcall--123 121,MR. HOENIG.," It doesn't affect how I come out on this, but if I understand the conversations, if we made an 84-day loan and if during the period we found the institution's condition deteriorating, we could in the Reserve Bank's judgment change that to a primary credit loan, call that loan if we felt it necessary, have conversations with the primary supervisor, and deal with that loan whether it was 84 days or 28 days. That is my understanding. Is that correct? " CHRG-111shrg61513--112 Mr. Bernanke," Well, it is a difficult problem and one we are very focused on, as well. First of all, there is a tradeoff. Probably credit terms were too easy before the crisis. They have tightened up some. Lately, banks seem to have leveled out. They are not tightening any further, at least. But there is a tradeoff between making sure that you are really making good loans versus making sure that creditworthy borrowers are not denied. Now, our focus at the Federal Reserve has been to achieve an appropriate balance. We want to make sure that creditworthy borrowers who are creditworthy can obtain credit, and we have been very aggressive in trying to do that. We started with, again, these guidances, but these are instructions to our examiners as well as to the banks which say, first of all, that we strongly encourage banks to make creditworthy loans because it is good for the bank, it is good for the borrower, it is good for the economy. We have trained our examiners to take that approach. We have most recently put out yet another guidance on small business which actually says, you know, you should not be denying credit based on what business you are in, whether you are restaurant or whatever, or what geographic location you are in. Again, this issue about your collateral value. If that has declined, that should not be a reason not to make the loan. We are encouraging so-called Second Look Committees who look, again, at loans that have been turned down just to make sure that there is not a way to make that loan. So our guidances, our regulatory philosophy, our training of our examiners has been very focused on getting that appropriate balance. Now, I have said this in previous testimonies. People say, well, I am not convinced. What is your evidence? So since then, we have been really trying to do outreach and try to get information directly back from banks, small businesses. We have, for example, put questions in the NFIB's Survey of Small Businesses to get more information about their credit experience. We are requiring banks to provide us more information on small business loans. We have a series of meetings and programs at the Reserve Banks which bring together small banks, small businesses, community development organizations, and so on. We are doing our best to go out there and find out what is really happening, because in some cases, I mean, I think you would agree, in some cases, the regulator is a good scapegoat and---- Senator Bennett. Yes. I understand that. " Mr. Bernanke,"----and gets the credit for the problem. But the Federal Reserve, because we have interest, of course, in safety and soundness, but we also have interest in a healthy economy, and that insight that we get and that balance is very important. I realize it doesn't filter down to every bank and every situation, but we are making enormous efforts to get that balance. When you do talk to your business acquaintances, first, ask them who the regulator is who is causing the problem, because it is not always the Federal Reserve---- Senator Bennett. I think that is fair. " FOMC20070918meeting--96 94,CHAIRMAN BERNANKE.," President Fisher, you raised a legitimate issue, which I think I should address now. We will this afternoon be discussing this auction credit facility with a possible swap that would allow the Europeans to provide term dollar funding as well. This work has been going on for a few weeks. It has been very intensive. The staff has done a great job, but as you know and as Bill explained, the financial market conditions have improved somewhat in the past few days, and so we view it—I view it and I think the Board views it now—as a relatively close call as to whether such a facility is needed at this juncture. What I would propose to do is discuss it as planned on the agenda. We would like to have a thorough discussion and, if the Committee approves the contingent permission, to use it should market conditions appear, in our judgment, to warrant it. But just because, as you point out, there is some interaction with the monetary policy decision, I’d just like to say that, at this point, it is not by any means a certainty that we will go ahead and apply that particular agency." CHRG-111shrg56415--38 Mr. Smith," I would only add, Senator, that in the most successful period I know of in home lending in the United States, there were mainly two, maybe three varieties of loans generally in the underwriting standards world, as you say. There was a requirement of a downpayment, for standard documentation, and the people that made the loans kept them. And on the basis of that lending experience, we projected--the magicians on Wall Street did projections about the loans that weren't like that. So, I think there is--as you point out, the issue there is the issue of access to housing, and that is what it is. There is no free lunch and no easy answer. Senator Gregg. Thank you. Thank you very much for your testimony. Senator Johnson. Senator Bennet. Senator Bennet. Thank you, Mr. Chairman, and I would also like to thank the panel for your excellent testimony. Every weekend when I go home to Colorado, what I hear from small businesses is they have no access to capital, no access to credit, and we are in this, as the panel has talked about, in this remarkably difficult period where, on the one hand, the securitized market that blew up or imploded is now gone and has not been replaced, which is probably a good thing from a leverage point of view, but it hasn't been replaced. On the other hand, we have got this looming commercial real estate issue that is still out there. And sort of caught in between all that are our small businesses who need access to capital in order to grow and in order to deal with the unemployment rate that Senator Tester talked about and sort of this folding back on top of itself. And I wondered, Mr. Tarullo, you mentioned in your testimony at the beginning your view that maybe some more direct efforts--I think you described it as temporary targeted programs--might be necessary to get our small businesses access to the credit that they need, and I wonder if you could elaborate a little bit more on that, because I suspect you are right. And in addition to that, I would ask to what extent we think the current accounting regimes are ones that are either helping banks extend credit to small businesses or are intruding on their ability to do that. " CHRG-111hhrg55814--218 Mrs. Capito," The fact is, this is the third infusion of TARP funds, taxpayer dollars into GMAC. I don't know what category they would fall in and so I would say, I think that the adaptability issue that you talked about on the resolution, I would like to see an enhanced bankruptcy resolution that provides that partition from the government into the court systems. I think we can create an enhanced bankruptcy through our court system that could address these adaptability issues and the GMAC issue and other issues. And even some of your fellow Presidents of the Federal Reserve have spoken in favor of this because, and I'll just take one quote, there's a widespread relief that public funds will soften the blow to private creditors. And I think this is an option we need to look at as we're working this through. My last comment, question, sort of, and clarification would be, the whole secrecy issue here. You even, in questioning the gentleman from Alabama, basically said, once everybody is required to have larger capital requirements, those will be out in the public realm. There really is no secret in Washington, D.C., for long; they are not too easy to keep, so I think we think that there will be, in the public domain, knowledge of these institutions, and there will be, they will be in a separate class from our community bankers, our credit unions and our other financial institutions. And I think that's problematic because I think that does bring about, whether it says it or not, brings about the ``too-big-to-fail'' concept that we have just seen over the last year. " fcic_final_report_full--82 SUBPRIME LENDING CONTENTS Mortgage securitization: “This stuff is so complicated how is anybody going to know?” .............................................................................  Greater access to lending: “A business where we can make some money” ............  Subprime lenders in turmoil: “Adverse market conditions” .................................  The regulators: “Oh, I see” ..................................................................................  In the early s, subprime lenders such as Household Finance Corp. and thrifts such as Long Beach Savings and Loan made home equity loans, often second mort- gages, to borrowers who had yet to establish credit histories or had troubled financial histories, sometimes reflecting setbacks such as unemployment, divorce, medical emergencies, and the like. Banks might have been unwilling to lend to these borrow- ers, but a subprime lender would if the borrower paid a higher interest rate to offset the extra risk. “No one can debate the need for legitimate non-prime (subprime) lending products,” Gail Burks, president of the Nevada Fair Housing Center, Inc., tes- tified to the FCIC.  Interest rates on subprime mortgages, with substantial collateral—the house— weren’t as high as those for car loans, and were much less than credit cards. The ad- vantages of a mortgage over other forms of debt were solidified in  with the Tax Reform Act, which barred deducting interest payments on consumer loans but kept the deduction for mortgage interest payments. In the s and into the early s, before computerized “credit scoring”—a statistical technique used to measure a borrower’s creditworthiness—automated the assessment of risk, mortgage lenders (including subprime lenders) relied on other factors when underwriting mortgages. As Tom Putnam, a Sacramento-based mort- gage banker, told the Commission, they traditionally lent based on the four C’s: credit (quantity, quality, and duration of the borrower’s credit obligations), capacity (amount and stability of income), capital (sufficient liquid funds to cover down pay- ments, closing costs, and reserves), and collateral (value and condition of the prop- erty).  Their decisions depended on judgments about how strength in one area, such as collateral, might offset weaknesses in others, such as credit. They underwrote bor- rowers one at a time, out of local offices.  CHRG-111hhrg54872--171 Mr. John," That is easy, it is the consumer when it comes down to it. One of the problems we have been facing and the chairman pointed out that there were a few problems with State preemption prior to, I believe in 2005 or 2006 or so. However, we didn't have the same level of extremely activist attorneys general, most of whom are seeking to be senators or governors, who actively seek out situations and actively promote more than reasonable solutions to them. So we are much more likely in the current situation to have attempts by various ambitious State officials to move into and obstruct national markets. " CHRG-110hhrg44900--203 Secretary Paulson," You know, that's interesting. I have heard a number of people say that one of the reasons the price of oil has gone up so much is the dollar has depreciated. And yet when you look at the statistics, look at what has really happened, if you go back to February of 2002, the dollar has declined in value 24 percent, the price of oil gone up over 500 percent. And so again, I really think the price of oil is being driven by supply-and-demand factors, and the real solution here is to address both. There is not an easy, short-term solution, but there is a lot that has to be done. " FOMC20070918meeting--111 109,MR. EVANS.," Thank you, Mr. Chairman. To date, economic conditions in the Seventh District have changed little since our last meeting. We continue to expand at a modest rate, as reported in the Beige Book two weeks ago. Even after accounting for continuing declines in the housing sector, most of my contacts thought the national economy had softened. Outside of housing, they generally reported a modest deceleration rather than an abrupt change in conditions. Retailers thought that continued high energy prices were holding back consumers, but demand was not seen as deteriorating sharply. A similar slowing was reported on the hiring front. For instance, Kelly and Manpower experienced softer demand for temporary workers, but again this was not characterized as a general pullback in hiring. Many contacts added that finding skilled workers remained difficult, as President Fisher mentioned. In terms of the business outlook going forward, several directors and other contacts noted that many in the business community were apprehensive about the prospects for growth. They were concerned that these worries might soon begin to weigh more heavily on actual spending. For example, in the motor vehicle sector, both Ford and General Motors cautioned that the August sales numbers overstated the underlying strength in demand for vehicles. They thought some selective incentive programs had boosted the sales figures. I asked all my contacts about the effects of the turmoil in credit markets. Though it is still early, none of them thought that the recent financial turbulence was causing creditworthy nonfinancial firms to have unusual difficulty in finding adequate financing. As several people have said, many business people suggested that the situation is much better than what they hear from financial commentators on Wall Street. Of course, we heard many examples of difficulties from financial market contacts, and several have spoken about that already. Turning to the national outlook, three broad developments since our August meeting have influenced my views on the economic situation. First, financial conditions have become more restrictive. Second, the incoming data suggest a greater decline in housing and a somewhat weaker labor market. Third, inflation prospects have improved to the point where my outyear projections are within a range that many participants would view as consistent with price stability. These projections embed a path for the federal funds rate that is similar to the Greenbook assumption. With regard to financial conditions, I think it is useful to consider the situation relative to an assessment of a neutral or an equilibrium federal funds rate. Taking into account the slower growth of structural productivity, a neutral rate is likely between 4½ and 4¾ percent. The Greenbook-consistent rate is in this range. Until recently, one argument for keeping the target funds rate at 5¼ percent had been to offset otherwise accommodative conditions. As recently as June, we had very low risk premiums and ample liquidity for all types of private borrowing, including large commitments for private equity deals. Now, of course, overall financial conditions have tightened and in some markets have turned very restrictive. Clearly, this restrictiveness is a downside for growth. Whether it is as large as ½ percentage point, as the Greenbook assumes, is uncertain. In any event, the ongoing repricing of risk also adds a good deal of uncertainty to the forecast. You all know it is very difficult to forecast the impact of such financial turbulence. Recent history and Dave Stockton remind us of this. In the early 1990s, restrictive credit due to depositories’ capital adequacy problems had a significant impact on real economic activity. In contrast, in the fall of 1998, we thought financial conditions would impinge a good deal on the real economy, but 1999 turned out to be a very strong year for growth. Bottom line—and we all recognize this—we need to be careful how we react to the current financial situation. Turning more specifically to the outlook for growth, our Chicago forecasts have tended to be somewhat more optimistic than the Board staff forecast, and we remain so. That said, the incoming data have been softer than we expected. So we marked down our assessment of residential investment again, but not as much as the Board staff did—again, and the decline in payroll employment caused us to lower our near-term outlook somewhat. As long as the financial difficulties are contained, and that is our working assumption, we expect growth to return to potential by the second half of 2008, and we have a higher potential output growth rate than the Board staff. However, I admit that the risks seem weighted to the downside of this projection. With regard to inflation, the improvement in core PCE inflation earlier this year appears to have a bit more staying power than we thought it might. If aggregate demand does weaken, as expected, then there is less risk of inflationary pressures arising from constraints on resource utilization. Energy prices, though, are a concern. My contacts do not seem to have much difficulty passing cost increases through to their customers. Overall, however, we have core PCE inflation edging down to 1.8 percent next year and remaining near that rate in 2009. I see the risk to this inflation forecast, conditioned on the outlook for growth, as being fairly well balanced. Thank you, Mr. Chairman." FinancialCrisisReport--314 The report also found the credit rating “analysts [did] not view themselves as accountable for their actions,” since the rating agencies were subject to little regulation or oversight, and their liability for poor quality ratings was limited by regulatory exemptions and First Amendment protections. 1224 The report recommended “increased oversight for these rating agencies in order to ensure that the public’s trust in these firms is well-placed.” 1225 In 2002, the Sarbanes-Oxley Act required the SEC to conduct a study into the role of credit rating agencies in the securities markets, including any barriers to accurately evaluating the financial condition of the issuers of securities they rate. 1226 In response, the SEC initiated an in-depth study of the credit rating industry and released its findings in a 2003 report. The SEC’s oversight efforts “included informal discussions with credit rating agencies and market participants, formal examinations of credit rating agencies, and public hearings, where market participants were given the opportunity to offer their views on credit rating agencies and their role in the capital markets.” 1227 The report expressed a number of concerns about CRA operations, including “potential conflicts of interest caused by the [issuer - pays model].” 1228 The Credit Rating Agency Reform Act, which was signed into law in September 2006, was designed to address some of the shortcomings identified by Congress and the SEC. The Act made it clear that the SEC had jurisdiction to conduct oversight of the credit rating industry, and formally charged the agency with designating companies as NRSROs . 1229 The statute also required NRSROs to meet certain criteria before registering with the SEC. In addition, the statute instructed the SEC to promulgate regulations requiring NRSROs to establish policies and procedures to prevent the misuse of nonpublic information and to disclose and manage conflicts of interest. 1230 Those regulations were designed to take effect in September 2007. In the summer of 2007, after the mass downgrades of RMBS and CDO ratings had begun and as the financial crisis began to intensify, the SEC initiated its first examinations of the major 1223 10/8/2002 “Financial Oversight of Enron: The SEC and Private-Sector Watchdogs,” prepared by the U.S. Senate Committee on Governmental Affairs, at 6, 108. 1224 Id. at 122. 1225 Id. at 6. 1226 Section 702 of the Sarbanes-Oxley Act of 2002. 1227 1/2003 “Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets,” prepared by the SEC, at 4. 1228 Id. at 19 . 1229 9/3/2009 “Credit Rating Agencies and Their Regulation,” report prepared by the Congressional Research Service, Report No. R40613 (revised report issued 4/9/2010). 1230 Id. credit rating agencies. According to the SEC, “[t]he purpose of the examinations was to develop an understanding of the practices of the rating agencies surrounding the rating of RMBS and FOMC20080109confcall--21 19,CHAIRMAN BERNANKE.," Are there other questions for Dave? If not, if I could kick off the general discussion, I will talk a bit about how I see the economy. I have two main points to make. First, I think the downside risks to the economy are quite significant and larger than they were. Speaking as a former member of the NBER Business Cycle Dating Committee, I think there are a lot of indications that we may soon be in a recession. I think a garden variety recession is an acceptable risk, but I am also concerned that such a downturn might morph into something more serious, and I will talk about that in a moment. My second point is that I think that 100 basis points of easing may or may not be a rough offset, in terms of expectations, to the decline in demand that we have seen, but I don't think that we have done really very much at all in terms of taking out insurance against what I perceive to be the greater risk at this point. So let me address those questions just a bit. President Lacker already anticipated me in mentioning the regime-switching models of recession. Those suggest a nonlinear process: There are two states of the world--a growth state and a recession state--and the behavior of the economy is different in those two states. Those models fit pretty well, although, of course, like many econometric models they are mostly retrospective. But some of the indicators suggesting a switch are things like falling equity prices, slower manufacturing growth, rising credit spreads, and--an often very effective indicator--the fact that the federal funds rate is so far above twoyear interest rates at this point. Those would all be indications that the regime is about to switch, if it hasn't already. President Lacker also mentioned the idea of a stall speed. I presented some figures on that in a meeting in 2006. There have been situations of a 0.3 percentage point increase in the unemployment rate in a month that have been reversed, but there has never been in our case a 0.6 increase over a period of time that didn't translate into a recession and a much greater increase in unemployment. Similarly, there has never been a sustained GDP growth rate below 2 percent-- and we have a 1 percent forecast for 2008--that has not turned into a recession. Indicative of the kind of behavior that we have seen in the past, let me just refer to the last two recessions. Unemployment was 5.2 percent in June 1990, having been there for about two years. It jumped to 5.5 percent in July, by the next June it was 6.9, and the following June it was 7.8. In December 2000, unemployment was 3.9, it was 4.3 at the cyclical peak in March 2001, and ultimately it hit 6.3 in June 2003. So there is some tendency, once a stall speed is reached, for the economy to slow quite considerably. Again, like David, I don't know if we're there yet. Obviously, ex ante it's extremely hard to tell, but I do think the risks are at least 50 percent at this point that we will see an NBER recession this year. Now, as I said, the concern I have is not just a slowdown but the possibility that it might become a much nastier episode. The main mechanism I have in mind--there are several possibilities, but I think the financial markets are the main risk. Let me talk a bit about banks, which are at the center of this set of issues. I'm going to talk a bit about the 21 large, complex banking organizations (LCBOs). I have had some data worked up for me by the supervisory staff. Since August these 21 LCBOs have announced $75 billion in extraordinary markdowns associated with various credit issues. They have, on the other hand, either raised or plan to raise $50 billion in capital. Therefore, one might say, ""Well, that looks pretty good."" I think, though, on net that there is really actually quite a fragility here. Several factors are going to put pressure on bank capital going forward. First, they have been taking assets on the balance sheet, as you know--about $250 billion so far of semi-voluntary additions coming from off-balance-sheet conduits and others. It is hard to say how much contingent additional exposure they have. There are a lot of different estimates. For these 21 banks, the Board supervisory staff identified between $250 billion and $300 billion more of potential exposures to bring back on the balance sheet. The BIS, at the meeting I attended over the weekend, looking at the 20 largest international banks, estimated $600 billion. We don't know how much it is going to be, but the banks themselves are somewhat unsure about potential exposures. Loan-loss reserves are quite low for this stage in the cycle, about 1.4 percent, compared with, say, 2.5 percent during the headwinds period of the early 1990s, and that is partly a result of the SEC regulations, which have forced banks to keep their reserves low. There is a lot of concern in banks about additional credit losses and downgrades, concern about financial guarantors, and, of course, macro concerns. Finally--and I think this is one of the most worrisome things to me--we are beginning to see some credit issues outside of housing and mortgages. Credit card delinquencies have jumped in a few banks' home equity lines. There are concerns in commercial real estate, particularly in some regions like Florida and California. And with fair value accounting, as pricing goes down, even if you don't yet see a cashflow effect, you get immediate effects on capitalization. The implications of this, even if the economy continues along, say, the Greenbook's estimates, are that lending is going to be quite tight. Banks are reluctant to take loans onto their balance sheets because of the capital constraints. They are, in fact, raising their internal capital targets because of their concerns about credit losses and about additional off-balance-sheet responsibilities. We have seen contraction not only in the primary mortgage market but also in home equity lines of credit, and I suspect we will see tighter conditions for credit cards, CRE lending, and non-investment-grade corporates. A question is high-grade corporates. There has even been some deterioration in, say, A-rated corporations. I have had a lot of opportunities to talk to bankers. We had a meeting over the weekend in Basel between the central bankers and about 50 private-sector representatives. The thrust that I got was that things are going to be pretty tight. ""We are going to meet our regular customers' needs, but all of this is conditioned on no recession."" As one banker put it in our meeting, ""There is no Plan B."" So a concern that is evident is that, if economic conditions worsen notably, the effects on bank capital, on credit risk, and so on will create a more severe credit situation, which could turn a garden variety downturn into something more persistent. The other issue, of course, is housing. Credit markets and housing are interacting very closely. I think that residential construction is going to stop subtracting so much from GDP growth because there is a non-negativity constraint. Eventually, the declines in residential construction will have to stop, but we are pretty far from the non-negativity constraint on prices, and I think that is where the issue is. I have reviewed the staff's analysis of house prices. They make perfectly reasonable guesses about what house prices will do. But it is inherently very difficult, and there is a very wide range of possible outcomes. If the housing market continues to be weak and if credit continues to be tight, then the possibility of a much more significant decline in house prices, particularly in some regions, is certainly there; and that, in turn, would have significant effects on credit markets and on the economy. So I have tried to be quick; I don't want to take too much time; but I see a lot of indications that a recession may well happen. Given the additional considerations of credit markets and housing markets, I am concerned that we might get something worse than, say, 2001. The other question I raised was, Have we done enough? We have done 100 basis points. Of course, it is hard to know. A few indicators: The Greenbook-consistent medium-term r*, which is an indicator of the real funds rate that leads to full employment in three years, was 3.3 percent in August 2007. It is currently about 1.8 percent, so that is a decline of 150 basis points. That is just one rough indicator of the decline in aggregate demand. I have not redone the Taylor rules, but for December the estimated forecast- and outcome-based Taylor rules showed a rate of about 4.0 to 4.1. Again, that would not include any risk-management considerations. That is just sort of an average over periods of both inflation risk and growth risk. I guess I would also mention the 2001 pattern, the most recent episode. The FOMC--many of you were there, I was not--dropped the rate 250 basis points in a little over four months in early 2001. Obviously, that was a much more aggressive episode. What about inflation? The fact is that we are in a tough bind here, and we don't have any easy, simple solution. We are going to have to balance risks against each other. We are going to have to do it in a forward-looking way, and we are going to have to try to make some judgments. I'll make a couple of comments. First, even assuming no recession, as the staff does, the staff has core and total inflation back into a reasonable approximation of price stability by 2009. As they note, wage growth has slowed; that doesn't seem to be incorporating any inflation pressures. The other thing I would say is that, if we do have a recession, inflation during recession periods does tend to fall fairly quickly. In the 1990 episode I mentioned before, between June 1990 and June 1993, core PCE inflation fell from 4.4 to 2.7 percent. Of course, in the 2001 episode, despite 550 basis points of easing, we went from 2.2 percent in the fall of 2001 to unwelcome disinflation in 2003. So should there be a recession, the inflation problem would probably take care of itself. Now, there is an argument--and Governor Mishkin's speech on Friday makes the case pretty well--that, when you have these kinds of risks, the best way to balance the growth and inflation risks is to be aggressive in the short run but to take back the accommodation in a timely way when the economy begins to stabilize. I realize this is not easy to communicate, but I think if we attempt to do so we can make some progress on that front. So, to summarize, we have a very difficult situation, but I do think the downside risks have increased and are quite significant. I don't think that our policy thus far has gotten ahead of the curve, so to speak, in terms of taking out insurance. Although, again, I'm not recommending any action today, I think we need to be cognizant of this issue as we go into the January and subsequent meetings. So let me stop there and open the floor for your reactions and comments. I'd like to know if you are comfortable not acting today--waiting until the January meeting. On the other hand, I am also interested in knowing if you share my assessments or if you don't. Let me be clear: I am not asking now for a commitment to any particular action in January. I am not asking for carte blanche. I am simply trying to see if we are all on the same page, or more or less on the same page, so that we can collectively communicate more effectively and I hope take the right actions when the time comes. So let me stop there, and Debbie will call on members. President Lacker. " CHRG-111hhrg48868--220 Mr. Lynch," I am not going to let you off the hook that easily. You know, you looked at these CDOs. I know that, by virtue of an Act of Congress back in 2000, CDOs are not regulated, but you did look at the condition of this company on the holding company end. What about information on what these instruments were valued at? I know you are saying we had no credit losses on the super senior tranch, but you have a mezzanine tranch and an equity tranch that were just deteriorating, and that has an impact on the margin for those senior tranches. I mean what about the information on that stuff that we would be looking for? " CHRG-110hhrg41184--50 Mr. Bernanke," Well, again, I don't necessarily want to try to explain fluctuations over short periods of time; financial markets move back and forth. But a couple of things have happened. There has been some back-up in longer-term Treasury rates--the safe long-term rates. But, again, I think a big part of the story is that even as the Fed has lowered interest rates, and as the general pattern of interest rates has declined, the pressures in the credit markets have caused greater and greater spreads, particularly for risky borrowers. And that to some extent--I would say not entirely by any means--offset the effects of our easing. Our easing is intended in some sense to respond to this tightening of credit conditions, and, I believe we have succeeded in doing that. But there certainly is some offset that comes from widening spreads, and this is what's happening in the mortgage market. " CHRG-111hhrg50289--33 Mr. Heacock," Thank you. We have not backed off at all. As I said before, we wrote more SBA loans than any other lender in South Dakota last year, and it is continuing this year. As far as non-SBA loans, we had a record year last year and it is continuing very, very strong. Credit unions nationwide, for the most part, have plenty of capital to lend, and we have had, I know, locally some financial institutions that are not willing to lend to some small businesses. Also, they are changing some terms and conditions. They are coming to us. Oftentimes we can help them. Sometimes we cannot, but we are there and available and have the funding. " FOMC20070807meeting--163 161,VICE CHAIRMAN GEITHNER.," Don’t give up yet. “Risk premiums in financial markets have increased, credit conditions have tightened for some households”—it is true that you don’t really know what the source of the increase in risk premiums is, but it is true that risk premiums have increased. Volatility itself is not particularly interesting from a policy perspective, and as many people have said, we’re not here to damp volatility. The considerations relevant to the macroeconomy and to financial market stability in some sense are what happened—and that’s a different way of saying it." CHRG-111shrg55117--68 Mr. Bernanke," But I do think that examiners should be appropriately weighing the fact that profitable lending to creditworthy borrowers is good for the bank and that maintaining those relationships is good for the bank. At the Federal Reserve, we have for a long time tried to communicate that message, and we have ongoing training, workshops, manuals, and other communications with the examiners and with the regional directors of supervision to try and put that message through. Now, I have to admit that it does not always get through, but, on the other hand, it is also probably true that, you know, bank terms and conditions just are going to be tougher now for a while given the difficulties in the economy. And so, you know, not everybody who was used to getting credit is going to get credit, but to the extent that we can continue to make loans to creditworthy borrowers, we really want to support that, and we are trying to put that message to our examiners. Senator Martinez. I think your statement is very helpful and I think also, with no question, that what used to be a good credit may not be a good credit in current circumstances, and we have to be wary of that. But along the same lines, the Federal Reserve implemented a TALF program to restart the securitized debt markets and my question has to do with the commercial real estate and the potential shortfall there. What do you think in terms of your program for the private commercial real estate lending, investing, and what may be coming in the months ahead, which is a very, very serious situation. " FinancialCrisisInquiry--428 MAYO: You know, as I listened to Mr. Blankfein, he brought up one word that hit me that I think, if I’m still doing this job 20 years from now, is going to stick with me. And that’s when he said, “rationalized.” We rationalized what we were doing based on the circumstances at the time. And I think one of the conclusions of your hearings throughout this year, that’s a warning to the future. Look how much we rationalized the activities that were taking place in the industry. So I very much agreed with that. And with regard to Morgan Stanley, Mr. Mack mentioned there was just too much leverage at the firms. That’s an easy call, and you can certainly track that. Well, let me yield to... CHRG-111hhrg74090--174 Mr. Rush," Ms. Hillebrand? Ms. Hillebrand. Yes. Thank you, Mr. Chairman. Under the one rule writing many enforcers model, we want it to be as easy as possible for the FTC to bring the cases in its existing jurisdiction as well as to enforce the CFPA rules. If the Commission recommends a shorter time period, we would want you to look at that very seriously. We think a waiver process also could help here. The Commission and the CFPA could agree that for this kind of case we don't need to know in advance and for these other cases we need a shorter period. " CHRG-110hhrg46595--49 The Chairman," Before I get to Mr. Wagoner, I want to make an announcement for us. Managing this fairly is not always easy, but many of the Members got to ask questions of the auto industry and the Union last time, and then others asked of the second panel. I am going to reverse that. I am going to begin by recognizing any Member on the Democratic side who did not get to ask questions of this panel. We will then go to others. So I just tell you that in advance so you have a chance to formulate your questions. We will then pick up the regular rotation. Mr. Wagoner, please go ahead. STATEMENT OF G. RICHARD WAGONER, JR., CHAIRMAN AND CHIEF FOMC20081029meeting--207 205,MS. YELLEN.," Thank you, Mr. Chairman. In the run-up to Halloween, we have had a witch's brew of news. Sorry. [Laughter] The downward trajectory of economic data has been hair-raising--with employment, consumer sentiment, spending and orders for capital goods, and homebuilding all contracting--and conditions in financial and credit markets have taken a ghastly turn for the worse. It is becoming abundantly clear that we are in the midst of a serious global meltdown. Like the Board staff, I have slashed my forecast for economic activity and now foresee a recession with four straight quarters of negative growth starting last quarter. I wish that I could claim that I place a lot of confidence in the sobering forecast, but I am sorry to say I can't. In fact, I think we will be lucky if the adverse feedback loop that is under way doesn't wrench us into a much more pronounced and more protracted downturn. The outlook for inflation has shifted markedly, too, with the days of heightened upside inflation risks behind us. In fact, I am concerned that beyond next year we run the risk of inflation falling below the level consistent with price stability. Even before the extraordinary deterioration in financial market conditions over the past few weeks, there were numerous signs that the economy had weakened dramatically. I won't recite the litany of disappointing data but instead try to touch upon some high, or I guess I should say low, notes based on what my contacts tell me. They are consistent with President Fisher's observations. Consumer purchases of durable goods, especially motor vehicles, have been particularly hard hit by the one�two punch of tight credit and reeling consumer confidence. The mood on showroom floors is downright grim. One auto dealer in my District reports that he is now experiencing the worst period in his thirty-plus years in the business. A home appliance retailer adds that he has never seen more uncertainty and gloom from both the retailers and the vendors. This sentiment is echoed by a large retailer who says simply, ""The holiday shopping season is going to stink."" Businesses are under siege from weak demand, high costs of borrowing, curtailed credit availability, and pervasive uncertainty about how long such conditions will last. Our contacts report that bank lines of credit are more difficult to negotiate. Many have become more cautious in managing liquidity and in committing to capital spending projects that can be deferred. They are even cutting back trade credit to customers. Even firms that are currently in good shape report that they are hunkering down, cutting back on all but essential spending, and preparing for the worst. Our venture capital and private equity contacts tell us that they are instructing their portfolio companies to cut costs, put expansion plans on hold, and draw down existing credit lines. The market for commercial mortgage-backed securities has all but dried up, and lenders have also become less willing to extend funding. With financing unavailable, I am hearing talk about substantial cutbacks on new projects and planned improvements on existing buildings, as well as the potential for distress sales of properties whose owners will be unable to roll over debt as it matures. The deterioration in overall financial conditions since the September FOMC meeting is truly shocking. Even with today's 900-point increase in the Dow, broad indexes are still down about 20 percent, and the latest data suggest house prices in a freefall. Baa corporate bonds are up about 200 basis points since our last meeting, low-grade corporate bonds are up a staggering 700 basis points, and to top it all, the dollar has appreciated nearly 10 percent against the currencies of our trading partners. The sharp deterioration in financial and credit conditions will weigh heavily on economic activity for some time. In addition, prospects for the one remaining cylinder in the engine of growth--namely, net exports--are bleak owing to the slowdown in global demand and the appreciation of the dollar. We now expect real GDP to decline at an annual rate of 1� percent in the second half of this year and to register two more negative quarters in the first half of next year. That forecast is predicated on cutting the funds rate to � percent by January, as assumed in the Greenbook, and also is premised on another fiscal package. An absolutely critical pre-condition for the economy to recover next year is for the financial system to get back on its feet. In that regard, I have been greatly heartened by the important actions that the Treasury, the FDIC, the Fed, foreign governments, and other central banks have taken in recent weeks to improve liquidity and inject capital into the financial systems. But we are fighting an uphill battle against falling home prices, an economy in recession, and collapsing confidence. It is not clear whether these steps will reopen credit flows to households and businesses, especially those with less than sterling credit. Under the Greenbook forecast we will see further large declines in housing prices over the next two years. Banks and other financial institutions will likely suffer larger losses than many had anticipated, and that will mute the impact of recent capital injections. The interaction of higher unemployment and rising delinquencies raises the potential for even greater losses by banks and other financial institutions and for an intensification of the adverse feedback loop we have worried about and are now experiencing. Such a sequence of events plausibly could lead to outcomes described in the ""more financial fallout"" alternative scenario in the Greenbook. There are considerable downside risks to the near-term outlook as well. As I mentioned, the most recent economic data have consistently surprised on the downside, and I see a real risk that the data may continue to come in weaker in the near term than the Greenbook has assumed. For example, a dynamic factor model that my staff regularly uses is much more pessimistic in the near term than is the Greenbook. This model aggregates the information contained in more than 140 data series. Based on the most recent economic and financial data available, this model predicts that real GDP will fall 2� percent in the fourth quarter. The model's pessimism reflects the combination of the recent weak data releases for the month of September, followed by the abysmal data that we have available so far for October, including financial market prices, regional business surveys, and consumer sentiment. Turning to inflation, the most recent data have been encouraging. Looking forward, the sharp decline in commodity prices, especially oil prices, will bring headline inflation down relatively quickly. More fundamentally, the considerable slack in labor and product markets will put downward pressure on the underlying rate of inflation over the next few years. A number of my contacts already report that their businesses are working on lower margins in the more challenging economic environment. I expect headline PCE price inflation to decline to about 1� percent in 2009 and core PCE price inflation to be 1� percent next year. I expect both inflation rates to edge down to 1� percent in 2010. Given the sizable downside risk to the forecast for growth, the risks to the inflation forecast are likewise weighted to the downside. In conclusion, I think the present situation obviously calls for an easing of policy, as I assumed in my forecast. Given the seriousness of the situation, I believe that we should put as much stimulus into the system as we can as soon as we can. " FOMC20060808meeting--122 120,MR. WARSH.," Thank you, Mr. Chairman. From a capital markets perspective, as I think about this decision, what matters more than the pricing of this issuance—that is, the decision on 25 basis points—is really what the after-market effects are. How is this security going to trade over the next weeks and months? When I think about the decision in that context, it puts the burden on the communications, which are only in small part in the message of our statement today. At the end of the day, I am willing to agree to a pause. But, again, I think that puts the burden on laying the predicate that we are in fact poised and prepared to act as necessary. That begins with our statement, but it doesn’t end there. Given the data that are likely to come in between this meeting and the next (a couple of CPIs, a couple of PPIs, maybe a revised PCE) and what’s likely to happen to some of the forward-looking market indicators (TIPS spreads, some of the commodity prices), I think it is very important that the markets understand, before the trading in the security gets very significant, the depth of our thinking on the subject and of the discussion around this meeting. The minutes can be part of that communication. Such communication is important so that they don’t perceive us when we meet next to be reacting to one or two pieces of data, the way they seem to have overreacted to one or two pieces of data last week, but really recognize the depth of our thinking on this subject. To be consistent with that view, I think Governor Kohn’s suggestion of indicating a pause as powerfully as we can is critical. The markets, in the first days, are going to take our pause to be a stop, as reflected currently in the Eurodollar futures contracts and the fed fund futures contracts. But we need to disabuse them of that view as quickly, as frequently, and as consistently as we can so that the pause does not become read as a stop. We will then have set out the conditions for the ways in which we might react if different data arise. Again, I think that the decision today is not an easy one. It’s important that the markets recognize that it is unlikely that our work here is done. With all that said, I’m prepared to support Governor Kohn’s suggestion." CHRG-111hhrg67816--7 Mr. Radanovich," Thank you, Mr. Chairman. I want to thank you so much for holding today's hearing on the FTC's role in financial consumer protection. Given the current economic downturn and the slow thawing freeze in the credit markets, this discussion is particularly timely. Abuses must have the disinfectant of sunlight shone brightly on them, and it is our responsibility as representatives of our constituents to examine the protections afforded to consumers by the law. Any credit scam that takes advantage of innocent consumers is deplorable and we must have our regulators pursue all those responsible for this kind of despicable crime behavior with vigor. My district is located in California San Joaquin Valley, which is suffering from one of the Nation's highest foreclosure rates due to the easy availability of credit, unfortunately, so the easy money was available to consumers because of deception and fraud. These were cases of mortgage fraud, appraisal fraud, and income fraud that all played a part in creating the current mess that we are in. It is reprehensible that people who may have been taken advantage of when they bought their house could now be victims in their time of need. Today, we focus on the Federal Trade Commission's efforts. The FTC deals with matters that affect the economic life of all our constituents. The Commission's consumer protection mission is to ensure consumers are protected from unfair and deceptive practices in or affecting commerce. That Herculean task puts the Commission in the position of overlooking a multitude of industries, and the Commission's responsibility to protect consumers of financial service products are a critical part of this work. The Commission helps to protect consumers at every stage of the consumer credit market from the advertising and the marketing of financial products to debt collection and debt relief. However, the Commission's legal authority does not extend to all entities that provide financial services to consumers. The FTC Act and the statutes the Commission enforces specifically exempt banks, thrifts, and federal credit unions. The FTC, however, had jurisdiction over non-bank financial companies including non-bank mortgage companies, mortgage brokers, and finance companies. As the lead consumer protection agency, it has the expertise and the experience that was recognized by our colleagues on the House Financial Services Committee last Congress. They developed legislation to improve the existing framework of the consumer protection regulations to better coordinate banking regulators rulemakings with those of the Commission, and while avoiding duplicative efforts in the government this coordinated approach to protect consumers of financial services is essential. The same rule should apply regardless of what entity sells the product. I am anxious to hear about the FTC's recent activity in this area, the cooperative efforts among agencies, and whether these efforts are effective. I do have concerns about some of the reforms that have been discussed over the years that would change how the Commission operates. As I mentioned, the FTC's jurisdiction is enormous. Except for the few exempted entities, the Commission's authority to promulgate regulations impacts nearly our entire economic spectrum. Unlike some other agencies who promulgate rules using the procedures of the Administrative Procedures Act, the FTC's rulemaking process is laid out in the Magnusson-Moss FTC Improvement Act. Congress established the Magnusson-Moss rulemaking procedures in the 1970's specifically to be more rigorous than the APA process, in part, to provide affected industries the opportunity to present arguments in an evidentiary hearing. The FTC must base any rule on that hearing record and substantial evidence must be presented to justify it. I am concerned that any significant change to this process would not allow for such careful consideration before rules are finalized. Congress set up the Magnusson-Moss process to be intentionally deliberative, but Congress also has been highly effective in enacting consumer protection legislation on specific issues and providing the Commission with APA rulemaking authority in those cases where it is warranted, such as the Do Not Call Act. I want to thank all our witnesses for being here today, and I look forward to their insight and expertise on how consumers can be best protected. I am particularly interested in hearing if there are any holes in the current law which prevent the FTC from pursuing bad actors and whether or not additional regulations would be effective in deterring unscrupulous lenders and others. If the testimony and the evidence we receive lead to the conclusion that the Commission should be doing more, including regulating entities that it currently does not, I stand ready to work with you, Mr. Chairman, to develop the appropriate legislation. Thank you, Mr. Chairman, and I yield back. " CHRG-110hhrg46596--496 Mr. Kashkari," Congresswoman, it is a great question and very hard to answer. The best I can do is to try to give examples of what might have happened, examples I mentioned earlier. Imagine if your constituents couldn't get access to their 401(k) plans, or they couldn't get money out of their checking accounts. It is possible, if their banks were failing. Their life savings could go way down, and just a complete freezing of the basic money flow in our economy. It could grind to a halt. I mean, the downside was enormous. It is easy to make hard decisions when the consequences of inaction are so great. And I don't know what else to say other than that. " CHRG-110shrg50416--27 Mr. Lockhart," Chairman Dodd, Senator Shelby, and members of the Committee, thank you for the opportunity to testify on the Federal Housing Finance Agency's response to the turmoil in the credit markets. I will begin by talking about our activities as the regulator of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, and then turn to TARP. There is no doubt that the mortgage market pendulum swung extremely widely toward easy credit, poor underwriting, risky mortgages, and even fraud. The market had to correct. But we need to prevent the pendulum from swinging too far in the other direction. Fannie Mae, Freddie Mac, and the 12 Federal Home Loan Banks have played a critical role in dampening that pendulum swing. In mid-2006, their market share of all new mortgage originations was less than 40 percent. With the demise of the private label mortgage-backed security market, their share is now 80 percent. On September 6th, FHFA placed Fannie Mae and Freddie Mac into conservatorship. Market conditions, compounded by a weak regulatory capital structure, meant that they were unable to fulfill their mission of providing stability, liquidity, and affordability to the mortgage market. A critical component of the conservatorship was the three Treasury facilities that were put in place. The most important one is a Senior Preferred Agreement, which ensures that the Enterprises always will have a positive net worth. These $100 billion each facilities, which have not been withdrawn on yet, are well over three times the statutory minimum capital requirements and last until all liabilities are paid off. Effectively, it is a government guarantee of their existing and future debt in mortgage-backed securities. Both can grow their portfolios by over $100 billion, which will further support the mortgage market, as will Treasury's mortgage-backed security purchase facility. Treasury has also provided the Enterprises and the Federal Home Loan Banks credit facilities to provide liquidity if needed. The Federal Home Loan Banks counter-cyclical capital structure has allowed them to play a critical role in supporting financial institutions and mortgage lending over the last year. Their secured advances to financial institutions have just reached $1 trillion, which is about 58 percent up from June of last year. The new legislation added the Enterprises affordable housing goals and mission enforcement to the responsibilities of the agency. I have instructed both CEOs to examine their underwriting standards and pricing. Earlier this month, Fannie Mae and Freddie Mac canceled a planned doubling of an adverse market delivery fee. I expect future changes to reflect both safe and sound business strategy and attentiveness to their mission. A critical component of stabilizing the mortgage market is assisting borrowers at risk of losing their homes by preventing foreclosures. Keeping people in their homes is critical, not only for the families and the neighborhoods, but for the overall housing market. Through August, the Enterprises have done $130,000 in loss mitigation activities, but they have to do a lot more. A more systematic approach to loan modifications is essential. Well before the conservatorship actions, we had asked the Enterprises to accelerate their loan modifications with features that included potential principal write downs and forbearance. We encouraged them to join the FDIC's IndyMac loan modification program. I expect loan modifications to be a priority, both as a matter of good business and supporting their mission. During this difficult time in our financial markets, the FHFA has been working with the Treasury, the Fed, the SEC, and the Federal banking agencies to monitor market conditions and coordinate regulatory activities. We have been assisting the Treasury Department as it develops ideas for the TARP. I also serve as a Director on the Financial Stability Oversight Board. Foreclosure mitigation is an important objective under the TARP program. The objective applies to all Federal agencies that hold troubled assets, including FHFA as conservator of Fannie Mae and Freddie Mac. In support of the TARP, and as a Federal property manager, FHFA will work to ensure the successes of these foreclosure minimization programs. In conclusion, FHFA and the housing GSEs have a critical role in returning the mortgage market to stability and preventing foreclosures. It will take time but I believe the many steps that have been taken will provide a much more solid foundation for creating a stable future for the mortgage markets and, most importantly, American homeowners, renters, workers, and investors. I look forward to working with the Committee and all of Congress in achieving this goal. Thank you. " FOMC20070807meeting--67 65,MR. HOENIG.," Mr. Chairman, the Tenth District economy overall continues to perform well, with strength in energy and agriculture partially offset by the weaknesses in residential construction. Developments since the last meeting include some softening in District manufacturing activity similar to that shown in the July ISM survey numbers and in other regional Reserve Bank indexes. We have also seen a slowing in overall employment growth. In contrast, consumer spending seems to be holding well in spite of higher gasoline prices. Indeed, reports from District directors and business contacts indicate a strong summer tourism season with increased air traffic and higher hotel occupancy rates throughout the western part of our region. The recent slowing in District employment growth has been somewhat surprising to us, given the activity in much of our region. Since the beginning of 2004, District employment growth has been running around 2 percent, and in the past few months has slowed to about 1½ percent. Geographically, the slowdown has been most notable in Wyoming, New Mexico, Colorado, and Oklahoma, and anecdotal information suggests that the slower growth is due more to a shortage of skilled and semi-skilled labor than to any weakening in demand. This anecdotal information is supported by new regional information on employment costs by the BLS. According to them, recent employment cost increases in these states have been well above increases nationally and in other parts of our region. Construction activity remains mixed, with weakness in residential construction offset to some extent by strength in commercial construction. Just an aside, when you talk about things that are on the horizon, we are a little concerned about commercial real estate because it is very hot right now and there is a fairly large portion of it on the books of the banks in our region. On the residential side, there is considerable variation across our region. In some areas where energy and agriculture are strong, housing activity is actually above normal. In other parts of the District, however, both national and local developers are experiencing the most difficult conditions in some time. In most District metro areas, inventories of unsold homes continue to rise, but the rate of increase has diminished somewhat in recent months. Turning to the national outlook, data released since the last meeting support the view that growth will pick up over the year. Compared with the Greenbook, I am more optimistic about both the near-term outlook and longer-run growth. Specifically, I think second-half growth is likely to be around 2½ percent. Growth in 2008 and 2009 is likely to be near potential, which we estimate to be around 2¾ percent. Housing obviously constitutes the major downside risk to growth over the next few quarters. I am not yet convinced, however, that recent financial market volatility and repricing of credit risk will have significant implications for the growth outlook. It is still reasonable at this point to think that the recent volatility will prove transitory, and the repricing of credit risk is, in that sense, desirable. I am also encouraged by the results of the July senior loan officer survey, which suggests no general tightening of bank credit conditions. Like the Bluebook, I think that Treasury yields are likely to move back up once the markets feel more comfortable about the state of the economy and credit conditions and realize that policy easing is not likely to be forthcoming. Although weakness in housing and tighter credit conditions have increased the downside risk to output, I believe that strength in consumer spending, exports, and government spending will help maintain moderate growth in the period ahead. With regard to the inflation outlook, recent data on core CPI and PCE continue to be favorable. However, I am expecting some pass-through of higher energy prices to temporarily boost core measures over the second half of this year. In addition, pressures from resource utilization and slow productivity growth remain. Thus, despite recent improvements, I continue to believe that some upside risk to inflation remains. Thank you." FOMC20080121confcall--33 31,MS. PIANALTO.," Thank you, Mr. Chairman. I support your proposal for a 75 basis point reduction in the fed funds rate today. At the time of our last call, I was hesitant about moving because it was in advance of some important data. Obviously, we got those data, and they were very weak. Financial conditions, as many have indicated, have also deteriorated. My conversations with the bankers in my District indicate that the earnings reports that are coming out will demonstrate that problems have spread beyond just the mortgage sector. They are also seeing deterioration in credit card and other consumer debt. I think that it is important that we move in a timely and an aggressive way. I don't think that there is much to gain by waiting another week. In this environment, I do believe that we should make every effort to make sure that we are more accommodative and not stay inadvertently restrictive, as the evidence suggests we are today. So I do support moving 75 basis points today. Thank you, Mr. Chairman. " FOMC20080430meeting--106 104,MR. LACKER.," Thank you, Mr. Chairman. Fifth District economic conditions softened further in recent weeks. Following a pop-up in March, our manufacturing contacts said that factory activity lost momentum in April. Services firms that we surveyed again reported tepid growth in their revenues, and retail sales continued to be very weak. In real estate, the story is mixed. Our housing markets continue to post generally slow sales, but recent anecdotes suggest some scattered firming. Realtors and others indicate that Northern Virginia and Maryland have seen a spring bounce in sales in recent weeks. One Realtor said that a factor supporting sales is that sellers now seem more willing to come off 2006 prices. The Charlotte market has also seen a spring bounce. Coastal areas in the Carolinas, hard hit until recently, are said to be more active lately. Of course, it is hard to know what these anecdotes mean on a seasonally adjusted basis, and contacts caution that it is too soon to call the bottom. In contrast, home sales are weakening in many other areas of the Carolinas, where markets had posted sales and price gains well after the national market had turned down. Residential construction in nearly all areas continues to weaken. On the commercial real estate front, conditions have softened somewhat, although in D.C. proper, commercial rents are firm and vacancies are low. Commercial construction activity is broadly softening. My reading of the national report since the last FOMC meeting is that the real outlook has not changed much. In particular, we still appear to be in a recession. Payroll employment has continued to decline, falling an average of 77,000 per month in the first quarter. Unemployment is rising, although it is still relatively low. Nonresidential construction is weakening, and the falloff in architectural billings is particularly discouraging. Other business investment has been soft as well. Consumer spending, like business spending, appears to have slowed to a crawl. The length and depth of the recession are likely to depend on stabilization in the housing market. The sharp decline in home construction has continued unabated, and outside of the one-month tick-up in the brand new, as yet untested, monthly home-price index from OFHEO, there's no sign of any bottoming in any of the national data on housing. Having said that, I noted earlier some scattered reports of a seasonable pickup in home sales. So there's a chance, perhaps only a slim one, that we'll see some stability in markets this summer. Concerns are often voiced about the possibility of broad spillovers from financial market conditions in the form of sharply tightening credit conditions for households and businesses. But if we look past the drama in wholesale markets and the end-user credit markets that gave rise to it (in housing and buyout financing), evidence of such spillover is hard to come by, at least so far. It is true that delinquencies have risen across a broad class of credits--commercial real estate, C&I loans, and auto and credit card portfolios, for example--and lenders are reporting tightening terms across many of these borrower classes. But that is generally what happens in recessions: Spreads widen and credit flows fall because many consumers and firms become genuinely riskier. So far, delinquency rates and credit spreads faced by consumers and firms appear to be well within the bounds of what happened in past credit cycles. More broadly, recent experiences have revealed important new information about the efficacy of some prominent financial market mechanisms--information that is, in turn, affecting the current behavior of financial market participants. Auction-rate securities, for example, seem to have worked well for decades because investors attached relatively low probability to contractual clauses that reset their rates and prevented their exit. Reaching those clauses has naturally caused investors to update their estimates of the probability of reaching those clauses, and the result has been much less--in fact, virtually nil--demand for those securities. Similarly, recent experience has brought dramatic revelations about the informativeness or lack thereof of credit agencies' ratings of assetbacked securities. Its revelations would seem to warrant fairly dramatic shifts in investor portfolios, just as a matter of Bayesian updating. These changing expectations in light of recent information revelation are just as much a change in fundamentals as the invention of the light bulb. Spreads in interbank markets certainly are elevated, of course, but one fundamental factor here is the continuing uncertainty about the severity of looming losses on mortgage-backed securities. Another fundamental factor is the demand for term funding by European banks about which uncertainty remains regarding mortgage-related losses that may be imminent. Those sources of uncertainty will persist as long as uncertainty about the bottom of the housing cycle persists. At our March meeting I had strong concerns about inflation, particularly the increase in fiveyear, five-year-ahead inflation compensation and the rising trend in overall inflation. Since then we received more-moderate inflation numbers for February, and five-year, five-year-ahead inflation compensation has backed off as well. Although I still believe that these TIPS spreads are too high to be consistent with stable, long-run inflation below 2 percent, it's heartening to see them come down following our March meeting. It seems reasonable to infer that the improvement in inflation expectations occurred because of the unanticipated emphasis on inflation risks in our statement and the 25 basis point surprise on the funds rate. That response, however, confirms for me the hypothesis that the previous erosion in expectations was caused largely by the aggressiveness of our January policy actions. I believe that substantial risks for inflation and our credibility remain. The Michigan survey number for 12-month-ahead inflation expectations popped up to 4.8 percent, a relatively large number. The March CPI was again too high, and further increases in food and energy prices in recent weeks will continue to press headline inflation upward. Persistently high headline numbers could become ingrained in household and business decisionmaking. I believe the risk remains that cutting the funds rate again will have undesirable effects on inflation expectations. The real federal funds rate using the Greenbook's forecast of overall PCE inflation is now between minus � and minus � percent. That seems like plenty of stimulus for now. Thank you. " CHRG-110shrg50369--82 Mr. Bernanke," One of the concerns that I have is that there is some interaction between the credit market situation and the growth situation--that is, if the economy slows considerably, which reduces credit quality, that worsens potentially the condition of credit markets, which then may tighten credit further in a somewhat adverse feedback loop, if you will. I think that is an undesirable situation. I would feel much more comfortable if the credit markets were operating more nearly normally and if we saw forecasted growth--not necessarily current growth but forecasted growth--that looked like it was moving closer toward a more normal level. So what I would like to see essentially is a reduction in the downside risks which I have talked about, particularly the risk that a worsening economy will make the credit market situation worse. Senator Bayh. Well, let me ask you--but I have got only 1 minute so I am going to need to hurry. I did have two questions. What aspect of the credit markets will you look to? And, in particular, I have been interested--you talked about the flight from risk. There have been some aspects of the credit market that seem to me to be almost without risk, and yet people are fleeing from those as well. These auction rate securities, very short term, the underlying assets, particularly in the municipal sector, virtually no risk of default, and yet that seems to have seized up as well. What do you think will lead people to begin to assume rational levels of risk again? And what indicia will you look to in the credit markets to reassure yourself that this situation is beginning to work itself through? " fcic_final_report_full--173 As one recent study argues, many economists were “agnostics” on housing, un- willing to risk their reputations or spook markets by alleging a bubble without find- ing support in economic theory.  Fed Vice Chairman Donald Kohn was one. “Identification [of a bubble] is a tricky proposition because not all the fundamental factors driving asset prices are directly observable,” Kohn said in a  speech, cit- ing research by the European Central Bank. “For this reason, any judgment by a cen- tral bank that stocks or homes are overpriced is inherently highly uncertain.”  But not all economists hesitated to sound a louder alarm. “The situation is begin- ning to look like a credit-induced boom in housing that could very well result in a systemic bust if credit conditions or economic conditions should deteriorate,” Federal Deposit Insurance Corporation Chief Economist Richard Brown wrote in a March  report. “During the past five years, the average U.S. home has risen in value by , while homes in the fastest-growing markets have approximately doubled in value.” While this increase might have been explained by strong market fundamen- tals, “the dramatic broadening of the housing boom in  strongly suggests the in- fluence of systemic factors, including the low cost and wide availability of mortgage credit.”  A couple of months later, Fed economists in an internal memo acknowledged the possibility that housing prices were overvalued, but downplayed the potential im- pacts of a downturn. Even in the face of a large price decline, they argued, defaults would not be widespread, given the large equity that many borrowers still had in their homes. Structural changes in the mortgage market made a crisis less likely, and the financial system seemed well capitalized. “Even historically large declines in house prices would be small relative to the recent decline in household wealth owing to the stock market,” the economists concluded. “From a wealth-effects perspective, this seems unlikely to create substantial macroeconomic problems.”  CHRG-111hhrg54872--117 Mr. John," I think an article from the Washington Post from Sunday has already been cited here. I was deeply disturbed, for instance, to see a Washington Post article last December which pointed out a low-income immigrant couple who were moved into a multi-hundred thousand dollar housing loan despite the fact they had a very low income. We could go through the list. And the list would be very long, both on a State and a Federal area. One of the problems the chairman has pointed out very effectively is that this is not one of the key responsibilities of the regulatory agencies. Now, I think you can make it a responsibility and make it an emphasis just as easy with a coordinating council as you can by massively disrupting the whole consumer regulatory system by creating a new agency. Mr. Moore of Kansas. But you do think existing law and practice worked to prevent the financial crisis last year? " CHRG-109hhrg31539--228 Mr. Pearce," And again, it kind of lets us know that we probably should be doing some things on our energy policies, because of the descriptions in the Middle East, a $10 or $15 increase would be fairly easy to achieve, fairly within reach. The problem in the Middle East then brings us up to a different point, and that is even the availability of crude oil at any price. And could you see a scenario that might play out where the lack of energy, the lack of ability to move products around could drive us toward deflation rather than inflation? Would that be a potential scenario if the price--let's say that there is no price at which the Middle East would ship oil to the rest of the world. " CHRG-110shrg38109--7 STATEMENT OF SENATOR JIM BUNNING Senator Bunning. Thank you, Mr. Chairman. Chairman Bernanke, thank you for being here today. To repeat what I told you at the Budget Committee hearing a few weeks ago, the Federal Open Market Committee did the right thing by stopping the increases in the Fed fund rates after the June 2006 Fed meeting. By holding rates constant, you have done the right thing ever since. After the latest increase, the stock markets took off and the cost of credit leveled off. If the Fed had chosen to continue hiking rates, mortgages and other forms of credit would have become less and less affordable to the average American. Over the last 2 years, the costs of credit, such as mortgages, student loans, and credit cards, have all increased. I am not sure how much more tightening consumers could have handled before serious harm was done to the economy. Higher interest rates accelerated the housing decline. We will not know the full extent of the damage for months, if not longer. If the Fed had not stopped when it did, we would have been in even more danger. You have been at the helm of the Fed for a year now. My initial fears were that you would be a carbon copy of your predecessor, yet you have done some things I have never seen your predecessor do: Embrace open and full debate. There is an old saying that there is a reason we have two ears and one mouth: It is often more important to listen than to talk. During your brief tenure at the Fed, you have made a serious effort to improve on how the Fed listens, but you know I am not going to let you off that easy, even though today is Valentine's Day. The people of my State and I have real concerns about the dangers that lie ahead for our economy. As this Committee discussed with Secretary Paulson last month, our constituents are nervous when they see more and more manufacturing jobs going to the Chinese. They are concerned about the future of the housing market. They are particularly concerned about the effects that the potential repeal of the Bush tax cuts will have on our economic recovery. You inherited an economy that was approaching a tipping point, and so far you have managed not to push it over. I urge you to act with caution and deliberation in the coming year. Finally, soon there will be two vacancies on the Board of Governors. I hope the President moves quickly to fill these positions with people who have real experience in financial services and commercial banking, not just ivory tower academics. I look forward to your remarks. Thank you, Mr. Chairman. " CHRG-110hhrg44901--3 Mr. Bachus," I thank the chairman. Chairman Frank, I am going to follow your lead and restrict my remarks to the real economy, which is the purpose of this hearing, and not some of the recent developments in the past week or two. Chairman Bernanke, looking at the economy, we had an overextension of credit. We had too easy of credit, it wasn't properly underwritten, and the risks were not taken into account. As a result of that, we have had, I think, massive debt accumulation in this country, and we are going through what is inevitable when people borrow more than they can repay. I think a second factor, and it may be in your remarks or questions, you can address this, but a tremendous amount of leverage and risk-taking and other risky and speculative investment practices and a lot of fortunes were made on the way up, but there is pain on the way down. As I see it, it is not an easy thing to go through, but it is a part of a market cycle. The third factor, and this is a factor that I think is the most important, is the high commodity prices, and particularly energy prices that have been a particular hardship on importing nations, and we are obviously an importing Nation. It has been a financial windfall to exporting countries. I have been to Abu Dhabi and Dubai, and the fabulous wealth that has been created out of really a desert society there in the past 40 years is just almost beyond belief. I think T. Boone Pickens, he is running a commercial right now, and he calls this, I think rightly so, the largest transfer of wealth in the history of the world. That, to me, and the effect it is having on Americans day-to-day, is our biggest problem. I believe it is the largest source of instability in our financial markets. I think that the consumers are stressed, they are paying high gas prices, high diesel prices, and they can't pay their other bills. They are even having trouble putting food on their tables. Finally, while we require the American people to live within their budget, we had deficit spending here, and have for some time, and there is a tremendous lack, I think, in Washington of financial discipline. The Federal Government has more obligations than it can fund today, but it continues to obligate itself, it continues to expand and create new programs, and it continues to assume responsibility for funding services that were traditionally in the province of local or State governments or families themselves. Obviously, all of these problems, the problem of tremendous mushrooming of extension of credit and debt accumulation, of overleveraging and risk-taking, of high energy costs, high food costs, high gas prices, and then a Federal Government that spent beyond its means, obviously there is no single approach we can take to getting ourselves out of this. I think the banks have repriced for risk. There has been a lot of--they have raised capital. I will state right here that I know there is a debate in this country on the overall financial stability of our financial system, but I, for one, think that we are well on our way to recovery in the financial system. I think the present stock prices of our banks don't accurately reflect the value of those banks. I think the stock prices are too low. The banks are sound, they are solid. I think the stock prices, right now you may have--I think there is a real--it is just a confidence factor. Anyway, we have had a retrenching and a correction, and I do worry about some attempts that we are doing to short-circuit the correction and the period of adjustment. I think long term they can deepen the damage. But, in contrast, there is something that I think we should do, and we can do now, and that is to address high energy prices. High energy prices mean higher production and transportation costs. Those increases are passed on to the consumers, and we saw that this morning, causing inflationary pressures. Particularly hard hit are those Americans, a million-and-a-half Americans, whose adjustable-rate mortgages are adjusting. Those families are facing a double whammy. To sum up, what I believe is needed now is a concerted bipartisan effort by Congress and the Administration to develop and implement a comprehensive energy and conservation initiative. It needs to be done now. It should have been last year or the year before that. I believe until we get a handle on our dependency on foreign oil, we are going to continue to have real severe problems. Thank you. " CHRG-110hhrg46594--76 Mr. Wagoner," Yes. What we are trying to do, Congresswoman, is also work on the ability of our finance companies to be able to go back to the kind of traditional funding that they have offered to all of our dealers; and we have been working with the captive finance companies, either fully owned or in our case partially owned, to work with the Fed to get better credit availability. Ms. Waters. GMAC has a letter here to your dealers that says, in response to difficult credit market conditions and recent actions by the Federal Reserve Board regarding the Federal fund rates, GMAC is making a change to its wholesale floor plan finance program. The following change is effective. And it goes on to talk about what it can no longer do. So what I am asking you, in addition to the work that you do with your captives, will you also commit to the floor plans that you are involved with to at least dedicate a billion dollars of this money to assist these dealerships? May I get those answers, Mr. Chairman? " FOMC20081216meeting--90 88,MS. CUMMING.," Thank you. Again, I'd also like to thank the staff for the excellent notes. It's useful to start out with our near-term goals, as most of us have done, to provide stimulus and support for the economic recovery and to prevent too large a fall in inflation. The root problems, I think, are worth focusing on for a second: insufficient global demand, hurdles to economic activity from a severely impaired financial system, and as I'll report tomorrow, behavior that is influenced by confusion and fear among businesses and households that are tending to reinforce the downward trend of the economy. That environment, I think, gives us some goalposts to look for in terms of framing the strategy. I find very appealing Marvin Goodfriend's characterization of the duality of the central bank's policy. We have a monetary and what he calls a credit policy at the same time. In normal times setting the fed funds rate influences financial conditions, especially credit markets, in a fairly predictable manner, and this Committee from time to time has discussed where overnight rates and financial conditions have diverged. In these times, we're observing a major disconnect between overnight rates and financial conditions that is reflected in huge spreads but also in a lack of transactions and in nonprice rationing in markets. So coming back to the question of what some of our goals are: To address the problems that we see, communication is really the essential element, and we should be aiming for maximum impact in whatever actions we take and also in our communications. I think, therefore, that we should bring rates down now as far as we think we can take them. But the more important decision is articulating what we are going to do going forward, why we are doing it, how long we are planning to do it, and under what conditions we would stop doing it. Some of the confusion that is out there about what the Federal Reserve has been doing reflects the fact that our operations really cover two very different kinds of things. On one side we are expanding liquidity and supporting the recovery of financial markets by the CPFF, the MBS purchases, and the upcoming TALF. In other facilities we are preventing catastrophic market outcomes through asset disposition, such as the Bear Stearns transaction, AIG, and the recent transaction we've had with Citi. In addition, there are a lot of technicalities and legalities to these facilities that make it hard for the general public to understand what we are doing. So more fundamentally we need to communicate what we want to accomplish, and that importantly involves our commitment to price stability, as many have said here in the sense of keeping prices in the medium term rising in line with our 1� to 2 percent preference, and our commitment to a resumption of sustainable economic activity. When I turn to look at what kind of facilities we should be thinking about going forward, once interest rates are down to their minimum level, there are really a few things that I would highlight. First, in many ways we could influence expectations about short-term policy rates through our long-term debt purchases, as many have said. In particular, when we try to lean against expectations expressed in the yield curve that rates are going to rise soon, and we're seeing some of that today, we can intervene in markets that directly affect major elements of aggregate demand, and I would see that as a very important role of our agency MBS program and also the CPFF to address where firms are really being starved of working capital. Because of its structure, the TALF provides a very broad umbrella under which we could do intervention, again, where we see credit markets failing and economic activity impeded by the lack of finance of a wide variety. I think that we should look at the CPFF and the TALF more as backstop facilities that provide the credit we need but also build in a kind of exit strategy so that, when spreads come down, there is an opportunity for the market basically to tell us, ""You can wind this down now."" We need to communicate the criteria by which we are choosing these markets. We have mentioned these three big market segments. I think simpler is much better than having something that's very complicated or having many, many facilities. As part of this, the crucial thing is to provide to the marketplace some kind of conditional commitment. If we don't feel that we're ready yet for the inflation target, certainly between this meeting and the next we really need to think about what kind of conditional commitment we could make--what conditions in the marketplace would lead us to feel that our work was largely done. I would also note, though, that the historical notes made the excellent point that the risk is that we withdraw stimulus too quickly--that we believe the patient is healing when, in fact, the patient is merely stabilized. So our commitment must be both ambitious in its level and compelling as it is communicated to the public. I think we need to return to the expository approach that the Fed and then-Governor Bernanke took during 2002 and 2003, by which we carefully laid out the elements, the foundation, and the expected outcomes of our approach in that period. As valuable as it was in 2002-03, it is even more valuable today, when confusion and anxiety are shaping behaviors that will amplify the downward forces in the economy. I also endorse the recommendation that many have made to think about a press conference. The need for reassuring communication to the public is, I think, very great. I would add two more thoughts. Of course, it is really crucial that we are coordinating our policy with Treasury, and there are many ways in which we do that today--certainly, we need coordination of fiscal and monetary policy. I frankly would like to see more of our asset-disposition activities taken on by the U.S. government so that it would be easier for us to describe the facilities that we have as supporting the market and restoring market functioning. I also believe, as I'm sure that many of you do, that we will probably need some kind of agreement with the Treasury vis-�-vis our exit strategy. I particularly underline the real possibility, which several have mentioned here, that we may want to raise interest rates well before the markets are really fully healed or fully sustainable by themselves. We'll need to be able to negotiate that in the sense of both the path we take and the understanding we have with the fiscal authorities. Then just to conclude here, I also very much want to endorse the point that President Rosengren made about needing to fix the banking system and doing it sooner rather than later. There really is no ability for the economy to function without a strong banking system. Certainly I believe that you are hearing, as I am, of many instances in which the rationing that is going on through the banking system right now is reaching a destructive potential. In that kind of world, I think we need to turn our attention to that. The Federal Reserve is one of the most important supervisors in our country and in the world, and I think we can do a lot to lead to the very tough actions that need to be taken there. Thank you. " CHRG-111hhrg48873--91 Mr. Kanjorski," Well, that being the case, I assume that you recognize that there is not an awful lot of sympathy up here to necessarily provide additional funds, not going on the merits of whether the funds are necessary. I, for one, am absolutely convinced that for orderly process we need additional funding, and probably will, as we did back in September and October, vote in favor of that funding. But it is not going to be an easy lift on behalf of the Congress. In light of those facts, what are you designing or what are you putting in place so that we could adequately inform the American people as to what the real problems are and what the potential solutions to those problems are so there are more partners in this act that we are going through? " FOMC20080724confcall--9 7,MS. KRIEGER.," Well, as I said before, we imposed it to provide us with some comfort that DIs could stretch toward extra collateral, should they need it during the term of a loan. It came against the background of a term primary credit program that didn't have any such requirements or expectations. So I think we were a little cautious about the measures that we were taking at that time. It is spelled out in the terms and conditions. I think the Reserve Banks have been comfortable administering it on auction day, and the DIs seem to understand it. Maybe they understand it too well because some of them have figured out that they can bring in collateral and withdraw it. " CHRG-111shrg51303--108 Mr. Polakoff," Correct. Correct. The FP is the one that is under the most intense scrutiny today. I go back and I look at what we did over the years as we examined this company on a consolidated basis. We had throughout the years, many times, recommendations for action either at the consolidated level or at the FP level for better risk management practices within FP. I stand on my prior statement, sir, that in 2004, we should have done a better job in identifying what the liquidity risk was associated with these credit default swaps and insisted on a plan to mitigate that risk. When the business stopped in 2005, what we had post-2005 was how do we handle this risk that is now on the books. I would also--I have to remind myself and others that in 2004, this was a AAA-rated company and we were in an entirely different financial environment than we are now. Many of our models, many of our analyses, many of our discussions were driven by the economy that we were operating in in 2004 and 2005. It is easy to look back now in 2009 with some, we should have done X, Y, and Z, and we should have. A post-mortem is absolutely appropriate in this case. Senator Martinez. I think that is fair, and I think Monday morning quarterbacking is always a much easier thing to do. I think that also applies to Governor Kohn and some of the things that we have been discussing about what did or didn't take place in September of 2008. I understand that. Now, tell me the relationship between the S&L holding company and the FMP part of the business. Was there a connection between the two, other than the fact that they were both part of the same holding company? " Mr. Polakoff," AIG FP was a subsidiary of the holding company, so---- Senator Martinez. Of the S&L holding company? " CHRG-110shrg50420--69 Chairman Dodd," In fact, that was a condition. Wasn't that a condition? " FOMC20080430meeting--102 100,MS. PIANALTO.," Thank you, Mr. Chairman. Regardless to whom I talk with these days, the conversation quickly turns to both the fragile condition of financial markets and the spectacular rise in energy and commodity prices. I had hoped that one of these problems would have gone away by now, but clearly that is not how conditions have unfolded since our last meeting. The bankers with whom I talked are paying close attention to their capital and liquidity positions. They remain concerned about wide bid�asked spreads and low trading volumes in a broad array of securities markets. Indeed, the repercussions of financial turmoil appear to have touched every channel of credit intermediation. It appears that a rewiring of credit channels is simply going to take some time to work out. The most significant financial news coming out of the Fourth District is the $7 billion investment of new capital into National City Bank. National City is the country's tenth largest commercial bank, and its problems with mortgage-related credits are now well known. National City still has much work to do to clean up its balance sheet, just as many other financial institutions with impaired capital positions must do before they can stand on solid ground again. Although the fragile state of the financial sector represents a pretty sizable risk to my economic outlook, the National City situation, along with other stories I'm hearing, suggests that modest progress is being made. With regard to District business conditions, the stories I hear remain downbeat. Commercial builders are reporting mixed though generally positive first-quarter numbers. But their expectations for retail sales in the stores that they lease out across the country have deteriorated, and they are fairly pessimistic about 2008 growth prospects. One large national commercial developer whom I talked with told me that, for the first time in his 45-year career, his company has seen sales declines in March in every retail center that they own across the country. The manufacturers I talked with indicated moderate first-quarter revenue growth as export markets, especially in Asia and Eastern Europe, are still helping to sustain production despite weak domestic demand. At the same time, manufacturers report intense commodity price pressures, and they report little resistance as they attempt to pass along the rising cost of commodities to their customers. The projection I submitted for this meeting shows real GDP growth under 1 percent in 2008, with virtually all of that growth coming in the second half of the year. This is a decidedly more pessimistic projection than the one I submitted in January but not materially different from the outlook when we met just six weeks ago. I have, however, boosted my headline inflation projection for 2008 compared with what I submitted in January, and it is somewhat higher than what I was estimating when we met in mid-March. Although I am still projecting that the slack in the economy will be sufficient to bring the core inflation number under the 2 percent threshold sometime next year, I am now anticipating a little more pass-through of commodity prices into core measures than I thought probable six weeks ago. Indeed, every time I see commodity prices ratcheting up, I become less confident that slack alone will be able to prevent an upward drift in the inflation trend. To be clear, I think the downside risks that we face in the real economy remain substantial, and I am inclined to believe that some insurance against those risks is probably warranted. But in taking such a step, I am inclined to judge that the downside risks we face in the real economy will be roughly in balance with the upside risks that we face from a rising inflation trend. Thank you, Mr. Chairman. " FOMC20071031meeting--84 82,CHAIRMAN BERNANKE.," Thank you. Thank you everyone. Let me try to summarize this discussion. It is a little harder than usual. Broadly, the macroeconomic news came in slightly better than expected during the intermeeting period. Housing has been very weak, as expected; but consumption, investment, and net exports were relatively strong in recent months. In the aggregate data, there is yet no clear sign of a spillover from housing. Most participants expect several weak quarters followed by recovery later next year. The risks remain to the downside but may be less than at our last meeting. One issue, given all these factors, is determining the equilibrium short-term interest rate. Financial market conditions have improved somewhat since our last meeting, with investors discriminating among borrowers and with the process of price discovery proceeding. There was general agreement that conditions are not back to normal and that it would be some time before that happened. Some suggested that a risk of relapse remains, should credit quality worsen or further bad news be disclosed. Lending conditions have tightened, particularly for mortgages, and securitization remains impaired. There is not yet much evidence that this tightening is affecting business borrowing, however, although financial conditions may have somewhat increased uncertainty among business leaders. Views on how consumption would evolve were mixed. Consumer sentiment is on the weak side, house prices are down, and oil prices are up, which suggests some weakening ahead. However, the labor market remains reasonably solid, which should support consumer spending. Anecdotal information about consumer spending was unusually mixed. Some saw evidence of growing weakness in consumption. This evidence included weak reports from shippers and credit card companies. Others saw the consumer side as slowing a bit but generally healthy. Investment, including investment in commercial real estate, may also be slowing somewhat; but again, the evidence is mixed. Manufacturing growth appears to be moderating. Other sectors— including energy, agriculture, high-tech, and tourism—are doing well. Core inflation has moderated, and there was generally more comfort that this improvement would persist. There was less concern expressed about tightness in labor markets and wage pressures. Energy prices and food prices could lead total inflation to rise, perhaps even into next year, and there is the risk of pass-through to the core. Similar concerns apply to the dollar and to export prices. Some, but not all, TIPS-based measures of inflation expectations have risen, and survey-based measures have been stable. Most participants saw inflation risks to the upside, but at least some saw them as less pressing than earlier this year. That is my summary. Comments? Well, again, as usual, it is hard to be the last person to speak, but let me make just a few comments. First, as always, the Greenbook was very thoughtful. The authors have done a good job of balancing the risks, and I find their forecast very plausible as a modal forecast. Housing does seem to be very weak, of course, and manufacturing looks to be slowing further. But except for those sectors, there is a good bit of momentum still in the economy. Having said that, I think there is an unusual amount of uncertainty around the modal forecast, maybe less than in September but still a great deal. Let me talk briefly about three areas: financial markets, housing, and inflation. A lot of people have already spoken about financial markets. Market functioning certainly has improved. Our action in September helped on that. For example, commercial paper markets are working almost normally for good borrowers, the spreads are down, and volumes are stable. One concern that we had for quite a while was that banks would be facing binding balance sheet constraints because of all the contingent liabilities that they had—off-balance-sheet vehicles, leveraged loans, and so on. That problem seems to be somewhat less than it was. Some of the leveraged loans are being sold off, some of the worst off-balance-sheet vehicles are being wound down. So there is generally improvement in the financial market, certainly. In the past couple of weeks there has been some deterioration in sentiment, and I see that as coming from essentially two factors. First, there were a number of reports of unusually large and unanticipated losses, which reduced the confidence of investors that we had detected and unearthed all the bad news. This problem will eventually be resolved, but clearly we still have some way to go to clarify where people stand. The other issue, which I think is more pertinent to our discussion, is about economic fundamentals. There was a very bad response, for example, to Caterpillar’s profit report, and so the market is appropriately responding to economic fundamentals as they feed through into credit concerns. From our perspective, one of the key issues will be the availability of credit to consumers and firms going forward. My sense—based on my talking to supervisors, looking at the senior loan officer survey, and talking to some people in the markets—is that banks are becoming quite conservative, and that is what Kevin said. It is not necessarily a balance sheet constraint but more a concern about renewed weakness in markets. It is also a concern about the condition of borrowers, about credit risk, and the demands of investors for very tight underwriting. Now, of course, tight underwriting is not a bad thing; it is a good thing. But from our perspective, we need to think about its potential implications for growth and, if you like, for r*. The biggest effect of the tighter underwriting, of course, has been on mortgage loans, although we have seen a bit of improvement in the secondary market for prime jumbos, which is encouraging if that continues. This is the area in which vicious-circle effects, which Vice Chairman Geithner and others have talked about, is most concerning. House prices, according to the Greenbook, are projected to fall 4½ percent over the next two years. Clearly, there is some downside risk to that. If house prices were to fall much more, that would feed into credit evaluations, into balance sheets, back into credit extension, and so on. So I think there is a risk there, as Governor Kroszner and Governor Mishkin also discussed. The corporate sector is not much of a problem. Good firms are issuing debt without much problem. I don’t really have much read on small business, but I have not heard much complaining in that area either. With respect to consumers, my guess is that we are going to see some effects on consumers. Certainly, home equity loans and installment loans have tightened up. We can see that in the senior loan officer survey. We don’t see that yet for credit cards, but since a lot of credit cards are used by people with subprime credit histories, I suspect that we will see some tightening there. So I do expect to see some effect on consumers from credit conditions. As has already been mentioned, an area we also need to note is commercial real estate. Financing conditions have already tightened there quite considerably, and spreads are much wider. The senior loan officer survey shows the tightening of terms and conditions that matches previous recessions, and CMBS issuance has dropped very significantly. You can debate whether or not this tightening is justified by fundamentals. On the one hand, vacancy rates remain low, and rents are high. On the other hand, it is still also true that price-to-rent ratios are quite high. If you calculate an equity risk premium for commercial real estate analogously to the way you calculate one for stocks, you would find that it is at an unusually low level, which would tend to suggest that prices may fall. So it is uncertain, I would say. Certainly one area in which we might see further retrenchment in commercial real estate is the public sector: Tax receipts are slowing, and that might affect building decisions. So I do think this is another area in which we will be seeing some effects from credit tightening. I should be clear—the Greenbook already incorporates a considerable slowdown in commercial real estate, but that means it will no longer offset the residential slowdown. I just want to make one comment about housing, which I think we all agree is a central source of uncertainty, both for the credit reasons I have discussed and in terms of prices, wealth, and other issues. Let me just make one point that I found striking anyway, which is that—at least from the Greenbook—the forecast of a strengthening economy by next spring and the second half of next year is very closely tied to the assumption that housing will turn around next spring. In particular, if you look at all the final demand components for the economy, other than housing, in 2007 those components contributed 3.5 percentage points to GDP. According to the Greenbook forecast, in 2008 all those components together will contribute 2.0 percentage points to GDP. So the fact that GDP doesn’t slow any more than 0.6 comes from the assumption that the negative contribution of housing next year will be much less than it was in this year. It is certainly possible—again, I think the Greenbook authors have done a good job of balancing the risks. But as we have noted, we have missed this turn before, and it could happen again. So let me just note that as an important issue. If we do miss on that turn, the other forecast errors for consumption and so on obviously would be correlated with that miss. Finally, let me talk for a moment about inflation. I want to share the concerns that some people have noted. If you wanted to be defensive about inflation, you could point out that the movement in oil prices and the dollar and so on is in part due to our actions. But it is also due to a lot of other things—for example, the dollar in broad real terms is about where it was in the late ’90s. In that respect, it is perhaps about where it should be in terms of trying to make progress on the current account deficit. Similarly, with oil, a lot of other factors besides monetary policy are involved. That said, I share with Governor Warsh the concern that the visibility of these indicators day after day in financial markets and on television screens has a risk of affecting inflation psychology. I do worry about that. I think we should pay attention to that. So I do think that is a concern, and we obviously need to take it into consideration in our policies, in our statements, and in our public remarks. I have one more comment on housing before ending. In thinking about the turnaround for housing next year, Governor Kroszner talked about resets and those sorts of issues. We spend a lot of time here at the Board thinking about different plans for refinancing subprime borrowers or other borrowers into sustainable mortgages. We have looked at the FHA and other types of approaches. A very interesting paper by an economist named Joseph Mason at Drexel discusses, at a very detailed institutional level, the issues related to refinancing, in terms both of the servicers’ incentives and of the regulatory perspective. Mason points out that there are some serious regulatory problems with the massive refinancing effort, including consumer protection issues, because refinancing can be a source of scams. There are also issues of safety and soundness because refinancing can be a way to disguise losses, for example. If you read that paper, I think you will be persuaded—at least I am becoming increasingly persuaded—that a significant amount of refinancing will not be happening and that we will see substantial financial problems and foreclosures that will peak somewhere in the middle of next year. So I think that is an additional risk that we ought to take into account as we think about the evolution of housing. Those are just a few comments on the general outlook. Let me just note, we will adjourn in a moment. There will be a reception and a dinner, for those of you who wish to stay. There will be no program or business, so if you have other plans, feel free to pursue them. A number of pieces of data, including GDP, will arrive overnight, and we will begin tomorrow morning with a discussion of the new data. Perhaps that will help us in our discussion of policy. Thank you. The meeting is adjourned. [Meeting recessed] October 31, 2007—Morning Session" CHRG-111hhrg48874--12 OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Ms. Duke. Thank you, Mr. Chairman. Chairman Frank, Ranking Member Bachus, and members of the committee, I am pleased to be here today to discuss several issues related to the state of the banking system. As you are all well aware, the Federal Reserve is taking significant steps to improve financial market conditions and has worked with the Treasury and other bank and thrift supervisors to address issues at U.S. banking organizations. We remain attentive to the need for banks to remain in sound financial condition, while at the same time to continue lending prudently to creditworthy borrowers. Indeed, the shutdown of most securitization markets and the evaporation of many types of non-bank credit make it that much important right now for the U.S. banking system to be able to carry out the credit intermediation function. Recent data confirm severe strains on parts of the U.S. banking system. During 2008, profitability measures at U.S. commercial banks and bank holding companies deteriorated dramatically. Indeed, commercial banks posted a substantial, aggregate loss for the fourth quarter of 2008, the first time this has happened since the late 1980's. This loss in large part reflected write-downs on trading assets, high goodwill impairment charges, and, most significantly, increased loan loss provisions. With respect to overall credit conditions, past experience has shown that borrowing by households and nonfinancial businesses has tended to slow during economic downturns. However, in the current case, the slow down in private sector debt growth during the past year has been much more pronounced than in previous downturns, not just for high mortgage debt, but also consumer debt and debt of the business sector. In terms of direct lending by banks, Federal Reserve data show that total bank loans and leases increased modestly in 2008 below the higher pace of growth seen in both 2006 and 2007. Additionally, the Federal Reserve Senior Loan Officer Opinion Survey on Banking Practices has shown that banks have been tightening lending standards over the past 18 months. The most recent survey data also show the demand for loans for businesses and households continue to weaken on balance. Despite the numerous changes to the financial landscape during the past half-century, such as the large increase in the flow of credit coming from non-bank sources, banks remain vital financial intermediaries. In addition to direct lending, banks supply credit indirectly by providing back-up liquidity and credit support to other financial institutions and conduits that also intermediate credit flows. In terms of direct bank lending, much of the increase last year likely reflected households and businesses drawing down existing lines of credit rather than extensions of loans to new customers. Some of these draw-downs by households and businesses were precipitated by the freeze-up of the securitization markets. The Federal Reserve has responded forcefully to the financial and economic crisis on many fronts. In addition to monetary policy easing, the Federal Reserve has initiated a number of lending programs to revive financial markets and to help banks play their important role as financial intermediaries. Among these initiatives are the purchase of large amounts of agency debt and mortgage-backed securities; plans to purchase long-term Treasury securities; other efforts including the Term Asset-backed Securities Loan Facility known as TALF to facilitate the extension of credit to households and small businesses; and, the Federal Reserve's planned involvement in the Treasury's Public-Private Partnership Investment Program, announced on Monday. The Federal Reserve has also been active on the supervisory front to bring about improvements in banks' risk-management practices. Liquidity and capital have been given special attention. That said, we do realize that there must be an appropriate balance between our supervisory actions and the promotion of credit availability to assist in the economic recovery. The Federal Reserve has long-standing policies and procedures in place to help maintain such a balance. We have also reiterated this message of balance in recent interagency statements. We have directed our examiners to be mindful of the procyclical effects of excessive credit tightening and to encourage banks to make economically viable loans, provided that such lending is based on realistic asset valuations and a balanced assessment of borrowers' repayment capacities. The U.S. banking industry is facing serious challenges. The Federal Reserve, working with other banking agencies, has acted and will continue to act to ensure that the banking system remains safe and sound and is able to meet the credit needs of our economy. The challenge for regulators and other authorities is to support prudent bank intermediation that helps restore the health of the financial system and the economy as a whole. As we have communicated, we want banks to deploy capital and liquidity to make credit available, but in a responsible way that avoids past mistakes and does not create new ones. Accordingly, we thank the committee for holding this hearing to help clarify the U.S. banking agencies' message that both safety and soundness and credit availability are important in the current environment. I look forward to your questions. [The prepared statement of Governor Duke can be found on page 82 of the appendix.] " FOMC20081029meeting--213 211,MR. ROSENGREN.," Thank you, Mr. Chairman. While the LIBOR�OIS spread has narrowed somewhat, the mutual fund industry is no longer experiencing waves of redemptions, and commercial paper market conditions have improved, we're still not back to the short-term credit conditions that prevailed before the failure of Lehman Brothers. This outcome is striking considering the historic interventions that have occurred in the past month. With all of the new government guarantees and equity infusions here and abroad, the limited improvement in short-term credit markets attests to the degree of concern and risk aversion prevailing in financial markets. These concerns are likely to become even more elevated if the economy slows to the degree expected in most forecasts. Like the Greenbook, our forecast anticipates a significant recession. The Boston forecast includes three consecutive quarters of negative GDP growth and results in an unemployment rate peaking above 7� percent. The weakening labor market and the large losses in housing and stock wealth make it quite likely that consumption will shrink in the second half of this year. While we need housing to reach bottom, mortgage rates relative to federal funds rates remain quite high, and further job losses are likely to aggravate the upward trend in foreclosures and add to the downward pressure on housing prices. With limited new home purchases and demand for vehicles weak, consumption of consumer durables is unlikely to recover until next year. Commercial real estate, which has held up reasonably well, all things considered, is likely to be much weaker next year as new and rollover financing is difficult to obtain and staff cuts and hiring freezes affect the space needed by businesses. More generally, firms are likely to have little incentive to make new investments until the severity of the downturn becomes much clearer. Unfortunately, many of our trading partners are likely to face an even more severe downturn, aggravated by their slow fiscal and monetary response to deteriorating economic and financial conditions. While the Greenbook assumes the stock market will rise by 8 percent for the remainder of this year--it looks as though that happened today-- " CHRG-111hhrg56776--206 Mr. Volcker," I would be glad to add a comment, because I think this is an old problem. I remember when I was a young fellow writing about the Federal Reserve. And the long-standing chairman of the Federal Reserve in the 1930's was one Marriner Eccles, who repeatedly complained in the 1930's, in the midst of the recession, that the other banking--the sole responsibility for banking supervision and other agencies--they were being too tough because they had had a lot of losses on their watch, and they were overreacting, in terms of strict regulations at a time when it was inappropriate, because the economy was mired in recession. There have been other times when, if you're just looking at banking regulation, that's your only responsibility, maybe you're going to be too easy when things are going very well, and the economy is on the verge of--you know, the party is getting a little too ebullient. I think, really, that the Federal Reserve is in a better position to get a balanced regulatory position, regulatory approach, simply because they are responsible for monetary policy and responsible for business activity, too. That is one of the strengths in keeping the Federal Reserve in the regulatory business, in my view. " CHRG-110hhrg34673--153 Mr. Bernanke," Well, the incidence of delinquencies and bankruptcies for the economy as a whole remains quite low. Because the job market is pretty good and incomes have gone up, wealth has gone up, the stock market is up, and so on. Most families, many of them, have home equity built up and have been able to manage their finances pretty effectively, and as I said, we have not seen any significant increase in financial stress in the broader economy. Now, there are pockets of problems, as I mentioned already several times, such as the variable rate subprime mortgage area. I think there are a number of approaches. The one that the Federal Reserve is particularly involved in is disclosures. We are responsible for Regulation Z, which implements the Truth in Lending Act, and it includes such things as the famous Schumer Box and other things that show to potential credit card applicants what are the terms, you know, what are the fees and so on. We are in the process now of completely reworking Reg Z for credit cards, for revolving debt, and we anticipate going out with a proposed rule in the next couple of months, and we have worked very hard on that. In particular, one thing we have done--people find it very difficult to understand the legalese that they see in the credit card applications, the credit card contracts, and yet of course the legal information has to be there. Otherwise, it is not a legitimate contract, and so the challenge is to create disclosures that meet the legal standards but that are also understandable, and so we have gone out and done a lot of consumer focus group testing and those kinds of things to try to find disclosures that will actually work in practice, and we hope that these new disclosures we are going to put out for comment in just a couple of months will be helpful in helping people understand, you know, the terms and conditions of credit cards and make them use them more responsibly. " FOMC20070628meeting--126 124,MR. LOCKHART.," Thank you, Mr. Chairman. I would like to speak earlier next time, so I don’t have to give credit to so many of the previous speakers—[laughter] including President Poole, who really said a lot of what I have to say. There wasn’t much change in the Sixth District economic picture during the intermeeting period, particularly regarding things that are relevant to the national outlook. So I am not going to devote a lot of time to discussing across-the-board conditions in the District. My staff’s outlook— and my outlook—for the national economy doesn’t differ much from the Greenbook analysis and forecast, so I also won’t detail small differences between those two forecasts. The Greenbook outlook reflects the baseline expectation of a diminishing drag on real growth from residential investment. Since our forecast largely agrees with the Greenbook, we obviously see the most likely playout of the housing correction similarly. However, as suggested in the Greenbook’s first alternative simulation, we may be too sanguine. I think this is really President Poole’s message about a recovery in the housing sector. That is to say, the downturn in residential investment will be deeper and more prolonged and possibly involve spillovers. So I would like to devote my comments, in a cautionary tone, to this particular concern. Credit available for residential real estate purchases is contracting, and the credit contraction, specifically in the subprime mortgage market, has the potential to lengthen the transition period required to reduce housing inventories to normal levels. This tightening of credit availability, along with higher rates, may affect the timeline of the recovery. One market of concern is the starter home market. The subprime mortgage market has been a major credit source for first-time homebuyers—although, as has been mentioned earlier, subprime mortgages are a small portion of the aggregate stock of mortgages. Subprimes were 20 percent of originations in 2005 and 2006, and if you added alt-A nonprime mortgages, you would get 33 percent of originations in the past two years. In many suburban areas, like those around Atlanta and Nashville in my District, much home construction was targeted at first-time buyers. We have heard anecdotal reports from banking and real estate contacts in our region that tighter credit conditions have aggravated the already sluggish demand for homes. The country’s largest homebuilder—there may be a debate with President Fisher—[laughter] so one of the country’s largest homebuilders, headquartered in Miami, reported on Tuesday a 29 percent drop in homes delivered and a 7.5 percent drop in average prices. But that is combined with a 77 percent increase in sales incentives. They attribute their negative sales experience to rising defaults among subprime borrowers and higher rates. That company’s CEO said that he sees no sign of a recovery, and he provided guidance of a loss position in the third quarter. Because of the major role that homebuilding—and, I might add, construction materials, particularly in forest products—plays in the Sixth District economy and because of some tentative signs of spillover, we will continue to monitor these developments in our District very carefully. As I stated at the outset, we share the basic outlook described in the Greenbook, but observation of the housing sector dynamics in the Sixth District has raised our level of concern that the national housing correction process may cause greater-than-forecasted weakness in real activity. If that is the case and inflation gains prove transitory, as suggested in the Greenbook commentary, we may be dealing with a far more challenging policy tradeoff than we are today. Thank you, Mr. Chairman." FOMC20080121confcall--53 51,MS. DANKER.," I will read the directive and then the statement and call the roll. ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee, in the immediate future, seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 3� percent."" The statement goes, ""The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3� percent. The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets. The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully. Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks."" Chairman Bernanke Vice Chairman Geithner President Evans President Hoenig Governor Kohn Governor Kroszner President Poole Yes Yes Yes Yes Yes Yes No " FOMC20070816confcall--22 20,MR. KOHN.," Okay. Well, you have the statement, I think, and I’ll be happy to read it. “To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board today approved temporary changes to its primary credit discount window facility. The Board approved a reduction in the spread between the primary credit rate and the FOMC’s target funds rate to bring the primary credit rate to 5¾ percent. The Board is also announcing a change to the Reserve Banks’ usual practices to allow the provision of term financing for as long as thirty days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained.” Just to repeat, our hope is that this breaks the logjam—that it sends a signal that we’re encouraging them to make markets without relieving them of the credit risk and that the signal will help the banks come to the collective judgment really that’s in everybody’s interest to start financing these securities." FOMC20080130meeting--31 29,MR. DUDLEY.," Those are a lot of questions. [Laughter] Okay, I'll take the easy one first. The TAF is completely sterilized. For every dollar that goes into the TAF we drain reserves, and we've been doing that mainly by redeeming maturing Treasury bills. Regarding whether these are additional funds to those entities, it is hard to know what they would have done if the TAF facilities hadn't been available. This may have funded some assets on their balance sheets that they otherwise would have decided not to fund. I think it is very difficult to know what that counterfactual is. It is hard to believe that in the system as a whole it led to a lot of additional funding. I would be surprised by that, especially given that we did sterilize reserves and didn't allow expansion of the balance sheet. In terms of the issue of crowding out, the way I think about the TAF is changing the composition of our balance sheet and changing the composition of the banking system's balance sheet. It's not crowding out. We are basically supplying Treasury securities by redeeming bills, and then the Treasury issues more bills that the markets want, and we are essentially absorbing collateral from the marketplace that's hard for them to finance elsewhere. So it is a change in the composition of the balance sheet. That's how I would think of the way it works. In terms of how we should evaluate the success, we don't know how much was the yearend. We don't know how much was monetary policy easing. But market participants view the TAF as very positive. I think that, if we were to discontinue it abruptly, they would be unhappy. There's no evidence to suggest that the TAF has caused any great harm. It looks as though the benefits, to my mind, are likely to significantly exceed the costs even though we can't measure those benefits very accurately. Regarding the foreign institutions issue--the choice between dollar balances from us versus dollar balances from foreign central banks--I think it was a little more complicated than that because, if I remember how we got to the foreign exchange swaps, they were essentially more or less conditional on our doing the TAF. They were willing to do the swaps if they could get the auctions in tandem with our term auction facilities. So my judgment would be that we probably didn't really have a choice of getting the dollars to those foreign banks through the ECB if we hadn't done the term auction facility. " FOMC20071206confcall--83 81,MS. YELLEN.," Thank you, Mr. Chairman. I support the swap arrangement, and I can also support the TAF. In thinking about the TAF, I tried to weight the potential costs and benefits of the program. It hasn’t been an easy task given the uncertainty about what’s responsible for the run-up in term funding spreads. So I thought about potential costs. I certainly don’t see them as particularly large. It is true that it may not have the desired effects, and one could argue that the Fed’s reputation would be tarnished by a failure to succeed, but I didn’t find this compelling. On the contrary, it seems to me that taking an innovative and proactive approach does a much better job of enhancing our reputation. The greater threat is not being willing to cope with what clearly is a very difficult and disturbed situation in money markets. I congratulate the staff. I think this does represent innovative thinking. On the cost side also, the TAF would subsidize probably low-quality borrowers, but I think that’s a side effect that any intervention that’s aimed at improving liquidity will have, and that’s an acceptable price to pay. On the benefit side, though, I guess I’m concerned that the benefits won’t be particularly large. I agree with the comments that have been made. I don’t quite see how the TAF solves the stigma problem. I think there will be stigma as long as the equilibrium rate ends up being a penalty rate, and I think that’s likely to deter bidding. So I guess I don’t really see that this is very advantageous—the TAF relative to changing the spread of the discount rate and the funds rate—but I do see the merit in the arguments that you’ve made about the predictability of the quantity of discount window lending and the desirability of international cooperation. I would say that to my mind the principal risk in introducing the TAF is that it may be seen by the Committee as a substitute for standard monetary policy action since I see it as essentially a kind of sterilized intervention that may have some but not a huge effect. I’m also concerned that it won’t change the cost of funding at the margin, as President Poole argued. I don’t expect the TAF to have large effects on financial conditions, and so it’s not going to affect my own views very much on what the appropriate policy measures are to take when we meet next week." CHRG-111hhrg56766--136 Mr. Bernanke," Well, first, let me say that we're not going to be monetizing the debt, but I think everyone understands the basic arithmetic here, that if deficits go on at 3, 4, and 5 percent of GDP and that picture, if you extend it beyond 2020, would probably get worse because entitlement spending, aging society and so on, that you'll get increasing interest payments and it will spiral out of control and the CBO will give you the same results. Again, it's very easy for me to say this because I don't have to grapple with these difficult problems, but it is very, very important for Congress and the Administration to come to some kind of program, some kind of plan that will credibly show how the United States Government is going to bring itself back to a sustainable position. " FOMC20061025meeting--121 119,MR. STOCKTON.," If you think about the extension of the staff forecast—basically, if you look at beyond the 2008 period—it’s easy to see how you get back to 2 percent. Beyond that, I guess our underlying assumption would be that you will have to get inflation expectations down if you want to have inflation below 2 percent over that longer term. Now, given the way that we typically run these simulations, you have to create an output gap. There could be other channels that the model can’t capture—perhaps talk or communications or something could shift that. As we have indicated, we don’t know the evidence that we would be able to present to you to assure you that that would be the case. But it looks as though, to get below 2 percent, more work would have to be done to get at those expectations." CHRG-111shrg57319--516 Mr. Killinger," The statement was I was passing on to some executives a letter that I received from somebody outside of the organization who had an opinion about Option ARMs, and part of why I was passing it on is to the folks to think through both what does this mean in terms of what investor interest might be and how we might need to explain about Option ARMs to the investors in our company, and also to take a look, again, if market conditions are changing and, if they are, is there anything else that we should consider doing in our Option ARM portfolio. Senator Coburn. Exhibit 11,\2\ you said, in April 2006, ``We may want to continue to sell most of the Long Beach originations until everyone gets comfortable with credit.'' Why do you think anyone would have wanted to buy what you were selling if the Long Beach product was bad?--------------------------------------------------------------------------- \2\ See Exhibit 11, which appears in the Appendix on page 414.--------------------------------------------------------------------------- " CHRG-110hhrg46591--438 The Chairman," The gentlewoman from California. Ms. Speier. Thank you, Mr. Chairman. And thank you for being here and for your participation. I will make this painless because I know I am the last to ask questions here. One of the things that is very apparent to me, and I think to all of us really, is if you have no skin in the game it is really easy to make mischief and get out there. And a lot of that went on in this crisis. You all are supportive of ceasing mark to market. And yet I worry that if we do in fact get rid of mark to market, that it is going to create an environment where banks can take on risks because there is not going to be the accountability that mark to market requires. So my question is, are you interested in seeing mark to market suspended for a short period of time because we are in this crisis, and then return to it? Or are you supporting doing away with mark to market completely? " FOMC20081216meeting--311 309,MR. HOENIG.," Thank you, Mr. Chairman. If we were still working with the framework of targeting the fed funds rate, I would prefer D, and I would accept C, and I would vote accordingly. But I think what I've heard in the past two days is that we have really abandoned that framework, and this is kind of a ratification of that. I think that our framework now is actually in A and B in the statement that we are going to ""expand its purchases . . . as conditions warrant."" If that's the case, then going with A, in which you don't set a fed funds rate or talk about it, is probably preferred. I also think that we're now in a credit policy type of framework, and it bothers me. I have a lot of sympathy for what Presidents Lacker and Bullard said. I would prefer, rather than a statement that says ""as conditions warrant,"" that we have some kind of a monetary base criterion for the future. This is something that we ought to think about. At the same time, I do not think that we should have inflation below optimal in this statement. I don't think we're there, and, at this point, I think it should not be hinted at. I think that ""purchasing longer-term Treasury securities"" goes with the conditionality statement anyway. We'll do what it takes, and if it takes purchasing longer-term Treasuries, that's it. That is what we have unless we go back and look at a new framework that we need to get out and talk about with the public, and I hope that as our meetings and our discussions progress, we begin to focus on that. Thank you. " FOMC20080625meeting--249 247,MR. ROSENGREN.," Okay. So roughly $100 billion. The numbers seemed to be in that range. Now, one of the reasons that we're worried about the tri-party repo was that the securities in that tri-party repo were very illiquid. Was Bear Stearns unusual in the amount of illiquid securities that were being financed? As we look down this list, is the nature of the tri-party repo across these different parties similar or different? You could have a tri-party repo with collateral that would be easy to liquidate, or you could have a tri-party repo with something very difficult so that the counterparty would have a difficult time actually selling it into a distressed market. From the work you all have been doing, are there big differences or not? " CHRG-111hhrg48875--206 The Chairman," The gentleman from Texas. Dr. Paul. Thank you, Mr. Chairman. The chairman in his opening statement talked about the problem being excessive leverage, and I certainly agree with that. And others refer to that as pyramiding of debt. And then we run into trouble, and we come up with the idea that regulations will solve this without asking the question: where did all this leveraging come from and how much of it was related to easy money from the Federal Reserve and artificially low interest rates? So I am very skeptical of regulations per se because I don't think that solves the problem. And of course, everybody knows I am a proponent of the free market, and this is not certainly free markets that got us into this trouble, and this certainly won't solve it. But, you know, in other areas we never automatically resort to regulations. When it comes to the press, if we had regulations on the press, we would call it prior restraint and we would be outraged. If we wanted to regulate personal behavior, we would be outraged and call this legislating morality. But when it comes to economics, it seems like we have been conditioned to say, oh, that is okay because that is good economic policy. I accept it in the first two but not in the third, and therefore I challenge the whole system. And it hasn't been that way forever. It has really been that way since the 1930's, about 75 years, that we in the Congress have deferred to the Executive Branch to write regulations, which are essentially laws. And yet the Constitution is very clear. All legislative power shall be vested in the Congress. So we write laws and we transfer this power. So essentially--we have done this for years--we have reneged on our responsibility. We have not met our prerogatives. And therefore, we participate in this. But in your position, you have been trained throughout your life to be a regulator, and that is something I know you can't deal with. But there is one area that I think that you might be able to shed some light on and work toward the rule of law because, you know, traditionally under common law--our system has always assumed that we are innocent until proven guilty. And yet when it comes to regulations, first we allow the Executive Branch to legislate as well as the court. But in the administrative courts, we are assumed to be guilty until proven innocent. You are in charge of the IRS. So this is someplace where, if there were a reasonable respect for the rule of law, that we could change that tone and assume that the taxpayer and the person that is on the receiving end of these regulations could say, hey, at least now the burden of proof is on the government to prove that somebody broke these regulations. And yet look at what we are doing endlessly. And yet I see that as the real culprit in all this because we are assuming the citizen is guilty. Could you comment on that and tell me what you might be able to do in changing the direction? " CHRG-111shrg51395--66 Mr. Ryan," Thank you for your question. We have given a lot of thought to a number of issues, and on some of these issues we do not have final decisions. I am talking now within the industry. For instance, we spent a lot of time talking about should we recommend the Fed immediately as the systemic regulator, and we have not come to that conclusion yet. If we had to do it right away, they are probably the best qualified to do it, but we think that the industry and the Congress, the American people, deserve a really comprehensive view. The same is true of who is systemically important. It is pretty easy to identify the early entrants because they meet the test that Professor Coffee has enunciated. They are too interconnected. They are very large. They are providing consolidated services to the citizens of this country and we need a better understanding of their interconnected aggregated risks. So the first group will be easy. The second group will be more difficult because they may not be so interconnected. They may not even be that large. But they may be engaged in practices which could have a very dramatic impact on our health. So our hope would be that we anoint a systemic regulator, maybe it is a new entity, maybe it is within Treasury, maybe it is the Fed, that we orient them in legislation toward preselection of the people who are very obvious, and that we give them the flexibility to include and actually to have people move out of systemically important status going forward. So once you are in it doesn't necessarily mean that you will stay in it. I think it is pretty clear, though, we all know the basic early entrants and they are our larger financial institutions. We, by the way, would not limit this by charter at all, so there will be banks, there will be insurance companies, there will be hedge funds, there could be private equity players. It is people who could have a dramatic effect on our lives. Senator Shelby. Professor Coffee, why should we continue to prop up banks that are basically insolvent, some of our large banks that are walking dead, so to speak, give them a transfusion, and there is no end in sight? Why should we do that rather than take over some of their--guarantee some of their assets and whatever we have to do and wind them down? " FOMC20070807meeting--124 122,MR. HOENIG.," Mr. Chairman, a couple of things. First, I am satisfied with the current policy. I think that for the moment our concern should still be on inflation, and I think our policy is designed to address that. In saying that, I also recognize—from my own observations and from what I’ve heard here today—that more downside risks are emerging and that we have brought the risks more in balance, I guess is the way to say it. Complicating that, of course, are the tighter credit conditions. I think they are probably transitory, but we won’t know that for a while yet—maybe by the next meeting. That leads me to conclude that I am comfortable with alternative B and its language because I think it recognizes this dynamic and puts it out there for the public. So I would stick with what we have in alternative B and then see how we develop between now and the next meeting. Thank you." FOMC20071031meeting--79 77,MR. WARSH.," Thank you, Mr. Chairman. I thought I’d just talk about four subjects today: first, spend a few more moments on the capital market conditions, which Bill did a great job of summarizing; second, talk about financial intermediaries; and third and fourth, talk briefly about implications for growth and inflation. In terms of the capital markets, I think it is important that we judge their state today not from where they might have been two weeks ago or from where they might have gotten ahead of underlying reality—if you look at credit spreads and equities—but from where they were before we last met or from where they were in the darkest days of August. I think these markets are at the very high end of what are reasonable expectations for improvement. As Governor Kohn suggests, it doesn’t mean that they can’t reverse themselves. It certainly doesn’t mean that they are solid—plenty of fragility is there. But all things considered, as a function of both time and Fed policy, there is, indeed, better sentiment; bid-asked spreads have narrowed; price discovery is at work; and differentiation and tiering are very real. I’d highlight a few markets that have gone into the category of being on more solid ground. Bill referred to the interbank funding markets. The multiseller bank-sponsored conduit is performing well. Prime auto finance paper has gone through quite a volatile period in the past couple of months but has now found its way to the good side, where I think those markets are increasingly open. High-quality paper is increasingly being received on terms that don’t look dramatically different from the way they would have looked before August. Another example is credit card receivables. Of course, as many others around this table have pointed out, there is no panacea. Serious problems remain in some asset markets, particularly housing and certain parts of structured finance. But I note that might be for good reason. I’d hesitate to call this poor market functioning. By and large, it may be that some investors don’t like the outcomes, but as the asset-backed commercial paper markets have separated the haves from the have-nots and the have-nots are without bank sponsorship and have poorer quality assets and poorer disclosure, they are having a hard time finding and securing bids. Another example might be some large financial institutions that are rolling over more of their funding on a shorter-term basis than they desire. There may be good reasons for that, and as we think about our policy tools tomorrow, we shouldn’t try to come to the rescue with any fixes for institutions that may not have been managed well or, at least, may not have had a capital structure that fit the risks. There are a couple of other indicators of continued concern. Obviously, the Treasury bill market has been quite volatile and is a pretty good reminder to us that these markets are not back to anything that we’d even want to consider normal. Another indicator that I look to in evaluating whether the capital markets are coming back to some normalcy is the percentage of cash holdings in money market mutual funds. In the pre-July period, money market mutual funds, particularly those that hold these prime-plus securities, would hold 5 to 10 percent of their assets in cash. On the darkest day in August, that was up to 45 percent. By and large, my sense is that the average now is something in the mid-20s. That suggests that there might be requests for redemptions and liquidations for which they need to keep cash available, but they are feeling a little better about their prospects and about some of the paper that they’re holding. On balance, I’d say it’s pretty easy for us to sit here and judge improvement. It’s a lot harder for us to judge success. I think President Plosser talked about the normalization in these markets, and we must hesitate to think that the markets before their August turmoil were normal. Risk premiums were abnormally low, and access to credit perhaps unusually easy. So in judging the success of time in our policy prescriptions, I think we’re having a hard time—at least I’m having a hard time—figuring out what are the new steady-state outcomes that are trying to be achieved. These markets appear delicately balanced between fear and greed. One example of greed, as we discussed in previous meetings, is some of the pay-in-kind, or PIK, securities with toggle features in the high-yield market. One of them was priced just last week between 97 and 98. So some of these corporate credits may well have improved in the eyes of the market beyond what we think might be sustainable. On the other side is fear. A new paradigm is trying to take root in the markets, but the risk of reversal remains very real. The marks on many leveraged loans look good. But if you judge the financial institutions that hold this paper, they are rushing to get the paper to market as soon as they possibly can, perhaps with a view that the corporate credit conditions won’t hold at these levels. Second, let me talk briefly about financial intermediaries. As we discussed before, after the tumult in mid-August, many of them retrenched. Then many of them tried to re-liquefy. At that time they were trying to revalue their securities. Now they are probably somewhere in the process of revaluation, review, and refinement. Some of them, after the earnings announcements of the past couple of weeks, might be going back to step 1 and trying to understand what the risks are and what their liabilities are. Some of the improvements that we saw in the capital markets after our September 18 meeting might have been upended or seemed so by a couple of announcements from a leading investment bank and commercial bank that represented a negative surprise to the markets. A couple of explanations are possible for why the market seemed to react not just with respect to the securities of those two banks. Were the losses and risk-management systems particular to those banks that called the risk management into question, or were they illustrative of losses to larger segments of their peer group owing to poor risk-management systems? It was probably a combination, but I guess the key question for me is whether we are seeing impairment of the entire financial sector or simply the realignment of the competitive landscape. I think the answer is the latter, but I’m not certain. The best-in-class comparables among commercial banks and investment banks seem to suggest that bifurcation is at work. If you look at the credit default swaps, at the profits, and at the share prices for the best in class of this group, they seem to have come out of the scare of a couple of weeks ago stronger and more profitable and, frankly, in much better shape. I would have thought that those sorts of entities would be putting opportunistic capital to work in a hurry, particularly when many of their competitors are down. I’m afraid that is not the case. Even they are playing defense in this market. We talk, I talk, about the resilience of our capital markets. What they tell many of us, I think, is that the way for them to be resilient is to be exceptionally prudent here. The risk-reward tradeoff for them suggests that this is a time to be careful. You can’t succeed if you don’t survive, and I suspect that many of them are still quite jarred by recent events. The profitability of most of these financial institutions has been significantly called into question. I suspect that the losses in the fourth quarter are going to look particularly bad, but I would expect that many of these financial institutions are asking themselves the question of what business they really should be in after all. Third, let me speak briefly about the implications for economic growth. To me there is no question that we have less market uncertainty than two months ago, and the prospects of some really bad tail events have dissipated somewhat; but there is still caution, as Vice Chairman Geithner said. Certainly, large multinational nonfinancial companies, excluding housing, seem to be holding up well, as represented by their bottom-up S&P earnings forecast for the fourth quarter of next year, and certainly there’s good news to report, as President Poole suggested, from many in the tech sector. Housing is, of course, as bad as the Greenbook has long suggested. So at the end of the day in terms of trying to judge what’s going on in the real economy, we go back to a discussion the Greenbook highlighted for us, which is the state of the consumer. Even though on balance I am a bit more optimistic than the Greenbook for GDP growth for the balance of ’07 and ’08, I have to admit that the conclusion that consumer sentiment has taken a hit seems, at least from my reading and my discussions with some business leaders, to be backed up by some very disappointing consumer spending for October. Having surveyed a few of the credit card companies, I think that it looks to many of them that October spending is really not at comforting levels. Nominal spending excluding fuel for their consumer base appears flat to down over the past four weeks. That is, I think, a rather remarkable outcome. Delinquencies have also ticked up a bit, but I would say that’s probably less disconcerting to me than what the credit card companies seem to be reporting as a proxy for retail spending. The key over the medium term, however, is job growth and real disposable income, in my judgment more important than the negative wealth effects from housing. Let me turn to the final issue for discussion—at least on my list—which is inflation risks. At the end of this six-week period, I must admit to being considerably less sanguine about inflation prospects and risks than the Greenbook. It is true that incoming data have not been bad at all. Some have even been pretty good, and inflation expectations are seemingly anchored. But as Governor Kohn suggested, I worry a lot about inflation psychology and the real effect of importing inflation given dollar weakness and the effect of commodity price increase pass-throughs on a breadth of products. Given the massive liquidity on the sidelines, given uncertainty in the global capital markets and the current political calendar, and given the rather large and growing expected discrepancies in interest rate differentials between us and our trading partners, I worry about outsized moves between the U.S. dollar and foreign currencies. A disorderly move in the dollar could prove very costly, even undermining foreign direct investment in the United States and perhaps threatening to unanchor inflation expectations, particularly if the judgments of this Committee aren’t well understood by the markets. I have never been a big believer in looking at artificial levels for prices or at charts to figure out where we should worry. Nonetheless, I must say a euro-dollar move beyond 150 strikes me as a level that the markets will be paying keen attention to. We’ll obviously talk about the policy tradeoffs involving these risks in the next round. Thank you, Mr. Chairman." FOMC20080310confcall--69 67,MS. YELLEN.," Thank you, Mr. Chairman. I strongly support the proposed term securities lending facility. I certainly agree that we face a situation in which systemic risk is large, and it's escalating very quickly. A dangerous dynamic has set in. Bill, Don, and all the memos did a great job in describing it. I think financial stability is truly at stake here, and although there are financial and reputational risks in pursuing this approach, it is a creative and well-targeted approach, and it is worth taking these risks to try to arrest the downward spiral in market conditions. Our monetary policy efforts have been seriously thwarted by the spread-widening that's taking place, and the rapid escalation we're seeing in these spreads--large increases in a matter of just the past couple of days in the absence of significant news that relates to the real creditworthiness of borrowers--suggests to me that the spread increases are, indeed, related to deteriorating liquidity conditions and not primarily to higher underlying credit risk. I think it is absolutely right to worry that liquidity problems are escalating into solvency problems. So as with the TAF, I am not 100 percent convinced that this is going to work, but I definitely think it is a good idea to move ahead and to do so quickly. " CHRG-111hhrg48674--8 Mr. Bernanke," Thank you. Chairman Frank, Ranking Member Bachus, and other members of the committee, I appreciate this opportunity to provide a brief review of the Federal Reserve's various credit programs, including those relying on our emergency authorities under 13(3) of the Federal Reserve Act. I will also discuss the Federal Reserve's ongoing efforts to inform the Congress and the public about these activities. As you know, the past 18 months or so have been extraordinarily challenging for policymakers around the globe, not least for central banks. The Federal Reserve has responded forcefully to the financial and economic crisis since its emergence in the summer of 2007. Monetary policy has been especially proactive. The Federal Open Market Committee began to ease monetary policy in September 2007 and continues to ease in response to a weakening economic outlook. In December 2008, the committee set a range of zero to 25 basis points for the target Federal funds rate. Although the target for the Federal Reserve rate is at its effective floor, the Federal Reserve has employed at least three types of additional tools to improve the functioning of credit markets, ease financial conditions, and support economic activity. The first set of tools is closely tied to the central bank's traditional role of providing short-term liquidity to sound financial institutions. Over the course of the crisis, the Fed has taken a number of extraordinary actions, including the creation of a number of new facilities for auctioning short-term credit to ensure that financial institutions have adequate access to liquidity. In fulfilling its traditional lending function the Federal Reserve enhances the stability of our financial system, increases the willingness of financial institutions to extend credit, and helps to ease conditions in interbank lending markets, reducing the overall cost of capital to banks. In addition, some interest rates, including the rates on some adjustable rate mortgages, are tied contractually to key interbank rates, such as the London Interbank Offered Rate or LIBOR. To the extent that the provision of ample liquidity to banks reduces LIBOR, other borrowers will also see their payments decline. Because interbank markets are global in scope, the Federal Reserve has approved bilateral currency liquidity agreements with 14 foreign central banks. These so-called swap facilities have allowed these central banks to acquire dollars from the Federal Reserve that the foreign central banks may lend to financial institutions in their jurisdictions. The purpose of those liquidity swaps is to ease conditions in dollar funding markets globally. Improvements in global interbank markets in turn create greater stability in other markets at home and abroad such as money markets and foreign exchange markets. The provision of short-term credit to financial institutions exposes the Federal Reserve to minimal credit risk, as the loans we make to financial institutions are generally short-term, overcollateralized, and made with recourse to the borrowing firm. In the case of the currency swaps, the foreign central banks are responsible for repaying the Federal Reserve, not the financial institutions that ultimately receive the fund. And the Fed receives an equivalent amount of foreign currency in exchange for the dollars that it provides to the foreign central banks. Although the provision of ample liquidity by the central bank to financial institutions is a time-tested approach to reducing financial strains, it is no panacea. Today, concerns about capital, asset quality, and credit risk continue to limit the willingness of many intermediaries to extend credit, notwithstanding the access of these firms of central bank liquidity. Moreover, providing liquidity to financial institutions does not directly address instability or declining credit availability in critical non-bank markets such as the commercial paper market or the market for asset-backed securities. To address these issues, the Federal Reserve has developed a second set of policy tools which involve the provision of liquidity directly to borrowers and investors in key credit markets. For example, we have introduced facilities to purchase highly-rated commercial paper at a term of 3 months and to provide backup liquidity for money market mutual funds. In addition, the Federal Reserve and the Treasury have jointly announced a facility expected to be operational shortly that will lend against AAA rated asset-backed securities, collateralized by recently originated student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Association. Unlike our other lending facilities, this one combines Federal Reserve liquidity with capital provided by the Treasury. If the programs works as planned, it should help to restart activity in these key securitization markets and lead to lower borrowing rates and improved access in the markets for consumer and small business credit. This basic framework could also expand to accommodate higher volumes as well as additional classes of securities as circumstances warrant, and Secretary Geithner alluded to that possibility this morning. These special lending programs have been set up to minimize credit risk to the Federal Reserve. The largest program, the commercial paper funding facility, accepts only the highest rated paper. It also charges borrowers a premium which is set aside against possible losses. As just noted, the facility that will lend against securities backed by consumer and small business loans is a joint Federal Reserve Treasury program. Capital provided by the Treasury from the Troubled Asset Relief Program will help insulate the Federal Reserve from credit losses and the Treasury will receive most of the upside from these loans. The Federal Reserve's third set of policy tools for supporting the functioning of credit markets involves the purchase of a longer term securities for the Fed's portfolio. For example, we have recently announced plans to purchase up to $100 billion of the debt of the Government-Sponsored Enterprises, which include Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, and $500 billion in agency-guaranteed mortgage-backed securities by midyear. The objective of these purchases is to lower mortgage rates, thereby supporting housing activity in the broader economy. The Federal Reserve is engaged in an ongoing assessment of the effectiveness of its credit. Measuring the impact of our programs is complicated by the fact that multiple factors affect market conditions. Nevertheless, we have been encouraged by the response to these programs, including the reports and evaluations offered by market participants and analysts. Notably, our lending to financial institutions, together with actions taken by other agencies, has helped to relax the severe liquidity strains experienced by many firms and has been associated with considerable improvements in interbank lending markets. For example, we believe that the aggressive liquidity provision by the Fed and other central banks has contributed to the recent declines in LIBOR and is a principal reason that liquidity pressures around the end of the year, often a period of heightened liquidity strains, were relatively modest. There is widespread agreement that our commercial paper funding facility has helped to stabilize the commercial paper market, lowering rates significantly and allowing firms access to financing at terms longer than a few days. Together with other government programs, our actions to stabilize the money market mutual fund industry have shown some measure of success, as the sharp withdrawals from funds seen in September have given way to modest inflows. Our purchases of agency debt at MBS seem to have had a significant effect on conforming mortgage rates, with rates of 30-year fixed rate mortgages falling close to a percentage point since the announcement of our program. All of these improvements have occurred over a period in which the economic news has generally been worse than expected and conditions in many financial markets, including the equity markets, have worsened. We evaluate existing and perspective programs based on the answers to three questions: First has normal functioning in the credit markets been severely disrupted by the crisis? Second, does the Federal Reserve have tools that are likely to lead to a significant improvement in function and credit availability in that market? And are the Federal Reserve tools the most effective methods either alone or in combination with other agencies to address the disruption? And third, do improved conditions in the particular market have the potential to make a significant difference for the overall economy? To illustrate, our purchases of agency debt and MBS meet all three criteria. The mortgage market is significantly impaired, the Fed's authority to purchase agency securities gives us the straightforward tool to try to reduce the extent of that impairment. And the health of the housing market bears directly and importantly on the performance of the broader economy. Section 13(3) of the Federal Reserve Act authorized the Federal Reserve Board to make secured loans to individuals, partnerships or corporations, ``in unusual and exigent circumstances,'' and when the borrower is, ``unable to secure adequate credit accommodations from other banking institutions.'' This authority added to the Federal Reserve Act of 1932 was intended to give the Federal Reserve the flexibility to respond to emergency conditions. Prior to 2008, credit had not been extended under this authority since the 1930's. However responding to the extraordinary stressed conditions in financial markets the Board has used this authority on a number of occasions over the past year. Following the Bear Stearns episode in March 2008, the Federal Reserve Board invoked section 13(3) to make primary securities dealers, as well as banks, eligible to borrow on a short-term basis from the Fed. This decision was taken in support of financial stability during a period in which the investment banks and other dealers faced intense liquidity pressures. The Fed has also made use of the section 13(3) authority in its programs to support the functioning of key credit markets, including the commercial paper market and the market for asset-backed securities. In my view, the use of section 13(3) in these contexts is well-justified in light of the breakdowns of these critical markets and the serious implications of those breakdowns for the health of the broader economy. As financial conditions improve, and circumstances are no longer unusual and exigent, the programs authorized under section 13(3) will be wound down as required by law. Other components of the Federal Reserve's credit programs, including our lending to depository institutions, liquidity swaps with other central banks, and purchases of agencies and securities make no use of the powers conferred by section 13(3). In a distinct set of activities, the Federal Reserve has also used the 13(3) authority to support government efforts to stabilize systemically critical financial institutions. The Federal Reserve collaborated with the Treasury to facilitate the acquisition of Bear Stearns by JPMorgan Chase & Company, and to prevent a failure of the American International Group or AIG. And we worked closely with the Treasury and the Federal Deposit Insurance Corporation to help stabilize Citigroup and Bank of America. In the cases of Bear Stearns and AIG, as part of a strategy to avoid impending defaults by the companies, the Federal Reserve made loans against polls of collateral. Activities to stabilize systemically important institutions seem to me to be quite different in character from the use of section 13(3) authority to support the repair of credit markets. The actions that the Federal Reserve and the Treasury have taken to stabilize systemically critical firms were essential to protect the financial system as a whole. And in particular the financial risks inherent in the credit extended by the Federal Reserve were, in my view, greatly outweighed by the risk that would have been faced by the financial system and the economy had we not stepped in. However, many of these actions might not have been necessary in the first place had there been in place a comprehensive resolution regime aimed at avoiding disorderly failure of systemically critical financial institutions. The Federal Reserve believes that the development of a robust resolution regime should be a top legislative priority. If specification of this regime were to include clear expectations of the Federal Reserve's role in stabilizing or resolving systemically important firms, a step we very much support, then the contingencies in which the Fed might need to invoke emergency authorities could be tightly circumscribed. I would like to conclude by discussing the Federal Reserve's ongoing efforts to inform the Congress and the public about its various lending programs. I firmly believe that central banks should be as transparent as possible, both for reasons of democratic accountability and because many of our policies are likely to be more effective if they are well understood by the markets and the public. During my time at the Federal Reserve, the FOMC has taken important steps to increase the transparency of monetary policy, such as moving up the publication of the minutes of policy meetings, and adopting the practice of providing longer-term projections of the evolution of the economy on a quarterly basis. Likewise, the Federal Reserve is committed to keeping the Congress and the public informed about its lending programs and its balance sheet. For example, we continue to add to the information shown in the Fed's H.4.1 release, which provides weekly detail on the balance sheet and the amounts outstanding for each of the Federal Reserve's lending facilities. Extensive additional information about each of the Federal Reserve's lending programs is available online, as shown in the appendix to this testimony. Pursuant to a requirement included in the Emergency Economic Stabilization Act passed in October, the Fed also provides monthly reports to the Congress on each of its programs that rely on the section 13(3) authorities. Generally the Fed's disclosure policies are consistent with the current best practices of major central banks around the world. With that said, recent developments have understandably led to a substantial increase in the public's interest in the Fed's balance sheet and programs. For this reason we at the Fed have begun a thorough review of our disclosure policies and the effectiveness of our communication. Today I would like to mention two initiatives. First, to improve public access to information concerning Fed policies and programs, Federal Reserve staff are developing a new Web site that will bring together in a systematic and comprehensive way the full range of information that the Federal Reserve already makes available, supplemented by new explanations, discussions and analyses. Our goal is to have this Web site operational within a few weeks. Second, at my request, Board Vice Chairman Donald Kohn has agreed to lead a committee that will review our current publications and disclosure policies relating to the Fed's balance sheet and lending policies. The presumption of the committee will be that the public has a right to know, and that the nondisclosure of information must be affirmatively justified by clearly articulated criteria for confidentiality based on factors such as reasonable claims to privacy, the confidentiality of supervisory information, and the effectiveness of policy. Thank you. I will be pleased to respond to your questions. [The prepared statement of Chairman Bernanke can be found on page 67 of the appendix.] " FOMC20080430meeting--176 174,MR. STERN.," Thank you, Mr. Chairman. Well, I have given serious consideration to both alternatives B and C, and I think a credible case can be made for either one. There are, of course, risks associated with adopting either one as well. On balance, I come out in favor of alternative B, for the following reasons. First, we are certainly not yet out of the economic woods. Although my forecast is for a relatively mild recession, I would not be particularly surprised if it turned out to be both deeper and more prolonged, given, among other things, the persistent overhang of unoccupied, unsold homes and the severity of the financial dislocations of the past nine months. As I have tried to emphasize, I think it could be dangerous to underestimate the effects of the financial headwinds now in train and likely, in my judgment, to get more severe. Second, and closely related to those observations, financial conditions remain quite sensitive. Even if improvement is now under way in some markets, I think it will be some time, as I said yesterday, before credit conditions are fully supportive of economic growth. To amplify a bit, I think we need to be a bit careful about the weight we put on the low level of the real federal funds rate per se for, as Governor Kohn pointed out yesterday, the credit situation is a good deal more complicated than that. My principal reservation about supporting alternative B has to do with the inflation outlook. The news here has not been uniformly bad, especially with regard to core inflation, but I am not convinced that inflation will abate in a timely way without policy action. On the other hand, I take some comfort from the fact that apparently financial market participants do not anticipate further reductions in the federal funds rate target beyond this meeting. I think the language associated with alternative B should help to reinforce the view that, at a minimum, a pause in the reductions in the target is not that far off, given what we know today. I think it important that we find opportunities to bolster that view when we can. Thank you. " FOMC20080724confcall--60 58,MS. PIANALTO.," Thank you. During the presentation, it was mentioned that many banks were asking for this longer-term TAF. I am not getting that request here in my District, but I wonder whether any thought was given to keeping the 28-day TAF and then adding the longer 84-day TAF. Is that even an option? The reason I raise this question is that I am concerned about the credit risk. We have had situations in which it has been difficult to assess whether an institution was going to stay in sound financial condition over a 28-day period. Obviously, it would be even more challenging over an 84-day period. So I just wondered if it 1s even an option to keep the 28-day TAF and add the 84-day TAF. " FOMC20070816confcall--92 90,MR. KROSZNER.," Yes, I certainly want to endorse the proposals and the approach going forward, and I also agree with Governor Kohn and with President Stern. Perhaps one amendment to the statement could be adding “going forward” to the end of the first sentence. So the beginning would read, “Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace,” the risks have increased. I think it nicely captures that, and it really focuses on the forward-looking nature of what we’re trying to do. It emphasizes what we’ve always talked about in our statements, and I think it fits very nicely with the structure of the statement itself. I agree that we are in an uncertain area where we don’t know whether or not this will be effective, but also we have uncertainty about the evolution of the housing market and about the evaluation of securities that are related to the housing market. Certainly it is helpful to provide some liquidity backstop to make it worthwhile for people to do the due diligence to make the investment, to try to find out what the securities are worth, because they think it’s more likely that someone is going to be there to trade with. I’m not sure that this will be the definitive way to achieve that goal, but I think it’s a worthwhile step to take. So I very much endorse this series of steps going forward." CHRG-111shrg62643--87 Mr. Bernanke," Well, the excess reserves in particular, which are created by Federal Reserve purchases of securities in the open market, are a strength of the system in the sense that they ensure that banks have easy access to large amounts of liquidity. But it is a separate issue from capital. Senator Gregg. Well, I guess my point is: Isn't our financial structure in pretty good shape right now compared to where it was a year and a half ago? And isn't it moving in the right direction? And so when you say ``unusual uncertainties,'' isn't at least one certainty that at least that element of the crisis which we confronted a year and a half ago has been settled out and is moving in the right direction? " CHRG-111hhrg52406--2 The Chairman," The hearing will come to order. I apologize for being late. Let me make a request of my colleagues. I guess we will go to the opening statements. I will begin. We have 10 minutes each. One of my frustrations as the ranking member, as the chairman and even previously has been the problem of getting adequate response to consumer complaints. It has been my experience that when you have an ongoing responsibility for broad systemic issues, consumer complaints can get crowded out. It is also the case that when you, and it has been my experience, have bank regulators whose primary role is the health and safety and soundness of the banks, consumer regulation, again, tends to get crowded out. We certainly have the history of the Federal Reserve previous to the co-chairman, who has been a great improvement, literally ignoring their consumer responsibilities. So I think the proposal that has come forward for a separate entity charged with protecting consumers from abuse is a very good one. The fear that this will be some out of control entity ravaging the financial sector is unsupported by anything in American history. There is no pattern of overregulation that I can see in the consumer area, and I don't see one here. So I am very pleased that the Administration sent us this recommendation. I am glad that we have with us one of the original authors of it, if not the original author, Professor Warren from Massachusetts. And I will just say as a matter of schedule, we will be spending a good deal of time between now and the rest of this congressional session dealing with the question of financial regulation. This is an important piece of it. It is my intention that following this hearing, we will be moving in July when we return to a mark-up on this. Ultimately, the financial regulation is going to be one bill, in part because of the United States Senate. Let me say, I was invited to speak on a project involving an entity that is going study the Senate. And I said, I thought that was going to be both important and fairly easy because it is a very significant institution with very few moving parts, which makes it somewhat easy to study it. But I do believe in the interest of this committee's doing its job the best it can that we should mark these up individually. So I do want to announce that this is a hearing that will lead to a mark-up in the period between the 4th of July and the recess at the end. So I urge members to pay very close attention. With that, I now recognize the gentleman from Alabama for 2 minutes. " FOMC20080430meeting--121 119,CHAIRMAN BERNANKE.," Thank you, and thank you all for very helpful comments. As usual, let me briefly summarize what I heard today and then make a few comments of my own. Again, in summary, data since the March meeting have been soft, and economic activity is weak. But the recent news has not generally been worse than expected. There was disagreement over whether we are technically in a recession. Most saw improved economic growth in the second half of 2008 with further improvement in 2009, although some saw more-protracted weakness. The housing sector remains weak, though there were reports of improvement. Starts and the demand for new houses continue to decline. Prices are falling. Inventories of unsold homes remain very high. Housing demand is affected by restrictive conditions in mortgage markets, fears that house prices have much further to fall, and weakening economic conditions. Retail sales, sentiment, and consumer spending have generally been soft, reflecting a long list of headwinds, including tightening credit, weaker house prices, and higher energy prices. Payrolls are falling, although there are some pockets of strength. Unemployment is likely to keep rising. It may remain somewhat high into 2010. We will soon see whether the fiscal stimulus package affects either the consumer or business investment plans. Possibly, liquidity-constrained consumers may respond more strongly than normally. Business sentiment is also relatively weak, reflecting in part credit conditions but also the uncertain prospects for the economy and continued cost pressures. Investment has softened somewhat, including declines in commercial real estate investment. Strength in foreign markets is helping support U.S. production and profits, especially manufacturing, although foreign economies may slow in the coming quarters. The energy and agricultural sectors are strong. Financial conditions have improved in the past month, with financing conditions better, credit risk spreads coming in a bit, and both equities and real interest rates up since the last meeting. Decent earnings, a sense on the part of some that the bulk of the write-downs in the banking sector have been taken, the ability of financial institutions to raise capital, and possibly Fed actions, including liquidity provision and the actions regarding Bear Stearns, have contributed to the improvement. On the other hand, many markets remain fragile, including the key interbank market and other short-term funding markets. Some expressed the view that moresignificant write-downs and financial stress lie ahead, as house prices continue to fall and the slowing economy weakens credit quality, and that the full impact of tighter credit has not yet been felt in the nonfinancial economy. Others, however, were less concerned about the real effects of the financial conditions. Financial conditions and the housing market probably remained the most important downside risks to growth, although energy prices were also cited. Readings on core inflation were moderate in the intermeeting period, although some of the reasons for improvement may be transitory. Oil prices have continued to move up, contributing to higher headline inflation. Other commodity prices have also begun to rise again. Many firms noted these strong cost pressures and indicated some ability to pass those costs along to consumers. Inflation breakevens showed improvement at some horizons since the March meeting, possibly reflecting lower risk premiums, though survey inflation expectations were higher. The dollar appreciated during the intermeeting period, but longer-term depreciation and rising import prices remain another source of pressure on inflation. Nominal wage gains remain moderate, however, and markups are high. Uncertainty about the course of oil and other commodity prices adds to overall inflation uncertainty and perhaps to inflation risks that are now somewhat more to the upside. Many participants expressed concerns about these upside risks, about inflation expectations, and about the maintenance of the Fed's inflation-fighting credibility. Any comments? Let me just add a few thoughts to what has already been said. On the real side, I think that I am probably somewhat more pessimistic than the median view that I heard around the table. First of all, I am reasonably confident that we are in a recession. We don't see these dynamic patterns of employment, sentiment, and so on without a recession being eventually called by the NBER. That fact, I believe, raises the risks of more-rapid declines in employment and consumer spending in the months ahead because there seem to be somewhat more-adverse dynamics in a recession scenario. Second, I remain concerned about housing, which is not showing really any significant signs of stabilization. Mortgage markets are still dysfunctional, and the only source of mortgage credit essentially is the GSEs, which are doing their best to raise fees and profit from the situation. Sales of new homes remain weak. Inventories of unsold homes are down in absolute terms, but they still are very high relative to sales. We heard this morning of yet even faster price declines for housing. As I've said several times at this table, until there is some sense of a bottoming in the housing market and in housing prices, I think that we are not going to see really broad stabilization, either in the economy or in financial markets. Now, there are some positives--exports, for example--which have kept manufacturing and other industries from declining as much as usual during a recession. Interestingly, this could be a mirror image of the 2001 recession. In 2001, the business sector was weak, and consumption and housing were strong. We could have the mirror image this time. In financial markets, there certainly have been improvements, and that is certainly encouraging. I agree with people about that. But we have heard a few people in the market say that credit losses and write-downs are in the ninth inning. As a baseball fan, I think we are probably closer to the third inning. Let me explain why I think that. The IMF recently projected aggregate credit losses on U.S.-based assets of about $945 billion worldwide, with about a quarter of those coming in the U.S. banks and thrifts. The Board staff has a somewhat lower number, around $700 billion to $800 billion, but they have a higher fraction in U.S. banks and thrifts. So the basic numbers are pretty similar in that respect. The staff projection for credit losses for U.S. commercial banks and thrifts, excluding investment banks, is about $215 billion for this year and next year and $300 billion if the recession is more severe. In addition, the staff projects about $60 billion in write-downs of CDOs and other types of traded assets. Now, most of those $60 billion write-downs have been taken. They are mostly held by the top banks, and they have mostly been already written off. However, of the $215 billion to $300 billion in projected credit losses, so far U.S. banks and thrifts have acknowledged only about $60 billion. So if you put together those numbers, you find that we are about one-third of the way through total losses. Now, there are, in fact, obviously some countervailing factors. Banks and thrifts have already raised about $115 billion in capital since the middle of last year, which essentially covers the losses announced so far. But that said, there is still a lot of deleveraging to go. There is going to be a long process of selling assets, reducing extensions of credit, and building capital ratios. This may not yet be fully felt in the real economy, but it will eventually be there. So I do think that we are going to see continued pressure from financial markets and credit markets, even if we don't have any serious relapses into financial stress. So, again, I am somewhat more skeptical about a near-term improvement in economic growth, although I do acknowledge that the fiscal package and other factors that the Greenbook mentions will be helpful. The question has been raised about whether monetary policy is helpful and what the stance of monetary policy is. I agree with the comment that the real federal funds rate is not necessarily the best measure of the stance of monetary policy right now. Let me take an example that was given in the New York Fed's daily financial report a couple of days ago, which was about the all-in cost of asset-backed securities backed by auto loans. According to this report, in February of '07, the three-year swap rate was about 5 percent, and the spread on AAA tranches of auto-backed ABS was about 10 basis points. The all-in cost was 5.07 percent for this particular asset. In February of '08, the three-year swap rate was 3.15 percent, almost 2 percentage points lower, but the spread on AAA tranches was 195 basis points. Therefore, the overall all-in cost of auto loan ABS was 5.36 percent. So the net effect is--well, is monetary policy doing anything? Absolutely. We have reduced the safe rate. We have brought down the cost of funds. But the spreads have obviously offset that. So what we have really done is essentially offset the effects of the credit crisis. Obviously, if we had not responded to the situation, those costs would be much higher, and the extent of restriction would be a lot greater. For these reasons, I really do believe that we need to take a much more sophisticated look at what the appropriate interest rate is. The Taylor rules, in particular, are just not appropriate for the current situation because the equilibrium real interest rate of 2 percent that is built into them is not necessarily appropriate. Let me turn to inflation, which a lot of people talked about today. First, let me just say that I certainly have significant concerns on the nominal side. In particular, I have a lot of anxiety about the dollar. Foreign exchange rates in general are not well tied down, and they are very subject to sentiment and swings in views. Therefore, although I think that the depreciation of the dollar so far is a mixed bag--obviously, it has effects on different parts of the economy--I do think that there is a risk of a sharper fall with possibly adverse implications, in the short run, for U.S. assets and, in the long run, perhaps implications for our position as a reserve currency and so on. So I think that is an issue to be concerned about. For that reason and for other reasons as well, I am very sympathetic to the view I hear around the table that we are now very, very close to where we ought to be, that it is time to take a rest, to see the effects of our work, and to pay equal attention to the nominal side of our mandate. I agree with all of that. So I am hopeful that in our policy discussion tomorrow we will be fairly close around the table. That being said, I do want to take a little exception to some of the discussion about inflation. There is an obvious and very elementary distinction between relative price changes and overall inflation. Let me ask you to do the following thought experiment. Imagine you are speaking to your board. Last year, as a first approximation, headline inflation was 4 percent, labor compensation grew at 4 percent, and oil prices rose 60 percent. Let's imagine that we had been so farsighted and so effective that we managed to keep headline inflation last year at 2 percent. The implications would have been, assuming that relative price changes were the same, that wages would have grown at 2 percent and that oil prices would have risen at 57 percent. In the conversation with your board, your board would say, ""This inflation is killing us. These costs are killing us. We have to pass them through."" They would, and they would be right. When there are big changes in relative prices, that is a real phenomenon, and it has to be accommodated somehow by nominal price shifts. So to the extent that the changes in food and oil prices reflect real supply-and-demand conditions, obviously they are very distressing and bad for the economy and create a lot of pain, but they are not in themselves necessarily under the control of monetary policy. If we give the impression that gasoline prices are the Fed's responsibility, we are looking for trouble because we cannot control gasoline prices. That said, of course we need to address the overall inflation rate. We need to address inflation expectations. All of that is very important. But, again, we need to make a distinction between relative price changes and overall inflation. Now, a more sophisticated response to that is, ""Well, maybe monetary policy is contributing to these relative price changes as well""; and I think that is a very serious issue. Certainly the dollar has some effects on oil prices. But keep in mind that a lot of the depreciation of the dollar is a decline in real exchange rates, which is essential in any case for balancing our external accounts. So, yes, the depreciation of the dollar, through our policies, has contributed somewhat to commodity prices. But compared with the overall shifts in relative prices that we have seen, I think it is not that large. There are other hypotheses suggesting that we have been stimulating speculation in a bubble, suggesting that low real interest rates contribute to commodity price booms. I don't want to take more time, but the evidence for those things is very limited. In particular, the fact that we have not seen any buildups in hoarding or inventories is a very strong argument against the idea that inflation expectations, hoarding, or speculation is a major factor in energy price increases. So, yes, the nominal side is very important. We need to address that. I agree with that. But we should try to help our audiences understand the very important distinction between real and nominal changes. I think I will stop there. If I can ask for your patience, we could do the briefing on the alternatives today and give ourselves more time tomorrow. Around the table, does that seem okay? I'll call on Bill English. " CHRG-111hhrg52406--235 Mr. Wilson," We have a position that we could support the concept with conditions, ``conditions'' being choice for the agent, consumer protection and to retain State-based as well, and so we have a dual position, a dual system of a position. So based on those conditions-- Ms. Speier. Meaning that you could forum shop then? " FOMC20070321meeting--303 301,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. I think three things about our current regime are worth reflecting on as to whether we can improve them. They are, first, the lack of clarity that exists about how we define our objective; second, the relative lack of texture that we provide about the outlook and the risks that underpin our decisions relative to some other central banks; and third, the way we run our internal conversation. In all these areas, because institutions are subject to inertia, we’re probably short of the frontier of the achievable, but I think it’s worth thinking about whether we can get closer to the frontier. I just want to raise some questions that I think are the hardest for us to work through in figuring out how we should evolve—and I think we should evolve. The first issue is about the balance between the benefits of the regime and the costs. The problem we face is that, based on what we know about the theory and the experience, the gains on expectations relative to what we have already achieved as a central bank look pretty small. I think there’s a broad consensus that they’re small. There’s a greater dispersion of views about what the costs are. Some of them are transition costs—how you get where you’re going and the political issues that surround that. Some of the costs are more uncertainty about the effect on how you operate going forward. The difficulty in judging the balance between what we think we know about the potential gains and those costs is that it’s hard to narrow uncertainty around the costs even after looking at the experience of other central banks. As many people have said, the experience of other central banks is pretty reassuring as to the costs. It’s hard to argue that they are worse off because they have achieved this in terms of outcomes. But some of that uncertainty is difficult to narrow ex ante, and a lot of it will depend on judgments that we make about the design of the regime. But even those judgments won’t fully answer the questions because, even if we tied them down now, they would still leave some uncertainty about the effect on our incentives, our behavior, and our management of a regime that will have much more exacting demands on communication. This problem is magnified by the fact that it is hard for us to adopt a regime with an explicit, fixed, relatively short horizon and to justify it as consistent not only with the dual mandate and the politics that surround that, but also—based on what we know about the experience of other central banks—with making sensible decisions about monetary policy that has multiple objectives over time. I don’t think that outcome is realistic for us as a Committee. Therefore, you’re talking about a range of options that are much toward the softer end—no fixed horizon, a horizon that varies according to the circumstances. The gains are going to look more tenuous. That’s one issue that I think is interesting for us to think through. The second issue concerns the initial conditions and the transition costs. If you’re going to adopt an objective that’s different from what people think your objective is and different from what best estimates of trend core inflation or trend inflation are today, those conditions and costs are very complicated. The dialogue between Rick and Jeff was very interesting. Both choices that exist today, if we were going to launch today, look very unattractive. You can basically decide that you will pick a target that’s pretty close to what your judgment is about trend because that is slightly above what the market infers our objective is. To validate a higher objective than what they have been inferring is awkward and hard to see. It would be easy to say that you’re going to adopt an objective substantially lower than that and believe that it would be easy for us to make it a simple, compelling political endeavor to achieve. So I think that issues about timing, initial conditions, and transition costs are very important and complicated to work through. But I thought you did a nice job of laying out the obvious issues on both sides. The third issue that I think is interesting is the question about the strength of the consensus necessary to go forward and how you deal with it. I think you’d need a very strong consensus to go forward. Some would view this change in regime by the Fed as the most significant since Humphrey-Hawkins, maybe since well before Humphrey-Hawkins, and so you’d want to have a very strong consensus. When you decide, on the strength of that consensus, you had better move forward. You have to have agreement. People have to agree that they’re going to operate under that regime, and I think we will, in effect, need to bind our successors to operate within that regime. Even if you have a regime in which, because of the legal or practical circumstances surrounding the institution, you have to have a periodic reaffirmation of that objective, in effect you’re binding our successors because we all agree that once you do this you can’t go back. We can’t contemplate the possibility that we’re going to adjust it in response to the changing preferences of different Committees over time. The fourth issue that I think is interesting for us is that we have to design a process of internal deliberation before launch that allows us to get more comfortable with the way we would operate. The aspects of our internal decisionmaking process that are least well suited to operating comfortably in any of the variants of the regime that we’ve been discussing are the lack of clarity that we live with about what our individual preferences are, about how that informs our different views about the structure, about how we inform our choices about appropriate, desirable paths for inflation, and about what monetary policy we think is consistent with that. As we’ve been discussing, we need to bring a little more internal clarity to that conversation. We need to know why we’re disagreeing when we disagree if we’re going to be better at thinking through difficult choices. There is also the related gap in how we talk about this stuff today, as Don Kohn said. Even if you only talk about a regime toward which you may be leaning or publicly disclose things about your forecast or move in the direction of a quantitative definition of inflation, we’re going to have to have a more explicit conversation about what we think is the appropriate path or slope of the path. Even if we don’t want to adopt a fixed horizon that varies over time and have that embedded in what we disclose about our forecast, we’re going to have to have more explicit conversations about what we think is an adequate, acceptable path toward trend. That is a complicated conversation to have, and in my brief experience on the Committee, we haven’t spent much time thinking about those kinds of choices. We’d prefer to live with squishiness, lack of definition, and ambiguity around those kinds of things because it is easier. I don’t think we’d have that option in a regime in which we’re moving toward more-frequent disclosure, three-year forecasts, and a central tendency of a path for these kinds of things. So my fourth issue is that we need to be careful in thinking through how we’re going to get comfortable with the evolution in our internal regime that’s going to be necessary to live within these kinds of regimes before we launch. My last point is—I’m not sure how to describe this—about the stability in any proposal we adopt. We’re all going to be tempted to soften the edges of what we’re agreeing on to make the consensus as broad as possible. We need to be careful that, if we adopt the intermediate things, we look at them and think they will stand up pretty well to external criticism and that we’re not going to find ourselves uncomfortable with having moved to that intermediate position. I think we’re going to get pulled naturally further toward more clarity. The discussion about the past—for example, whether we reveal the conditioning assumptions of our forecast—is the best example of that. That’s one instance in which you might decide that it’s expedient to agree today that we’re going to have an unstated, undisclosed, appropriate policy conditioning assumption for a forecast that has more clarity. But over time, as we’ve seen in other cases, there’s going to be a lot of pressure to say, “But what does this tell us really? We don’t really understand this.” So we want to think through this question about how to do something that is going to look stable over time. It doesn’t mean we have to fix it and say we would never evolve beyond that. But if we know we’re going to adopt something that’s going to be unstable and subject to pressure to move, let’s try to think through a bit in advance how we’d anticipate that pressure and respond to it. We can make the same point about the importance of thinking through the sequence of any evolution. I take Rick’s point about the importance of being evolutionary in that respect. Just as an example, if we decide that we want to go first with the transparency around our forecast before consensus or clarity on a quantitative objective as publicly announced, we should be sure that we think that’s an optimal chain of decisions, too. So the questions about sequence are going to be important to work through. I have a bunch of comments on the initial proposal for a narrative description of our forecast and the way uncertainty is captured. But if the Chairman permits, I will submit those directly to the staff for the record." FOMC20071211meeting--128 126,MS. YELLEN.," Thank you, Mr. Chairman. With respect to policy, I also favor alternative A, a 50 basis point rate cut. Let me explain my reasoning. Otherwise I certainly agree with what President Rosengren said. First, I think the equilibrium real rate of interest is low relative to its long-run average. The range of medium-run measures of r* reported in the Bluebook is between 1.8 and 2.3 percent, and this range includes the Greenbook-consistent measure and the staff’s Kalman filter model estimate of 2.1 percent. Market perceptions of future real interest rates are also very low, with yields on five-year Treasury inflation-indexed bonds now below 1¼ percent. I think the headwinds from financial market turmoil and the more general reassessment of risks that is taking place in global markets are good reasons why the equilibrium real rate may be low in the current situation. We do have historical precedence for this. For example, Kalman filter estimates of r* fell noticeably during the credit crunch of the early 1990s. Given the current state of the economy with inflation near a level consistent with price stability and resource utilization near its equilibrium level, policy should be close to neutral, which implies a nominal funds rate of 4 to 4¼ percent. The forecast and risk assessment must also enter the analysis. With an assumed 25 basis point cut at this meeting, the Greenbook foresees the economy barely skirting a recession, so any more bad news could put us over the edge; and the possibility of getting bad news—in particular, a significant credit crunch—seems far from remote. To my mind, the risk to the forecast and the risk of a vicious cycle, in which deteriorating financial conditions and a weakening economy and house prices feed on each other, argue for adopting a risk-management strategy that, at the very minimum, moves our policy stance to the low end of neutral—namely, a cut of 50 basis points—and I think it argues for doing so now rather than taking a “wait and see” approach and lowering it only grudgingly. This may not be enough to avoid a recession—we may soon need outright accommodation—but it would at least help cushion the blow and lessen the risk of a prolonged downturn. I should also say that my recommendation assumes that the implementation of the TAF, even if it succeeds in improving liquidity in the money market, will not appreciably alleviate macroeconomic conditions. Regardless of the policy actions taken at this meeting, I think we need to be very careful in these unsettled conditions about how we communicate our assessment of risks and likely future policy actions. We should maintain maximum flexibility so that our future actions can, in Governor Kohn’s well-chosen words, be nimble. If the Committee chooses to cut the funds rate 50 points, I would favor the assessment of risks from section 4, alternative B, in table 1. This appropriately leaves open what the future policy will be and stresses that it depends on developments. If the Committee goes with the 25 basis point cut, then I would support using the assessment of risks from section 4, alternative C, which states clearly that the predominant concern is the downside risk to growth. Otherwise I fear that market participants may mark up their expected path for policy over the next year, leading to further erosion in financial conditions. Finally, I would suggest that, given the long period of time between today and the next FOMC meeting, we be open to the possibility of a special intermeeting videoconference to assess economic and financial developments, and this meeting could also benefit from an assessment of the effects of the TAF once it’s in place." FOMC20070918meeting--131 129,CHAIRMAN BERNANKE.," Thank you, and thank you all. Let me just briefly summarize and make a few additional comments. Financial market conditions were a key theme of our discussion today. Recent developments in financial markets have been reflected in reduced willingness to take risk and in tighter credit conditions. Bank balance sheets are a potential constraint on credit extension. Participants were unsure about how long these conditions would persist, but the repricing of risk seems likely to be persistent. The tighter credit conditions will very likely weaken an already very weak housing market, as nonprime borrowers are rationed out and jumbo mortgage borrowers pay higher premiums. Mortgage rate resets and foreclosures pose further risks. Industries related to housing are naturally showing weakness. However, creditworthy borrowers are able to obtain credit. Second-quarter and third-quarter GDP figures may be solid, but even so there have been some signs of slowing in the economy, even before the financial market developments, notably in the labor markets and in housing. Auto output is also on the weak side. Labor markets do remain tight, and in general Main Street has been far less affected thus far than Wall Street. Consumer spending continues to grow along with incomes, and net exports remain strong. Financing should continue to be available for capital investment. There were some regional differences in soundings on business confidence and expectations, but in any case, uncertainty has increased. Some of the key questions include whether the further weakness of housing will spread to consumer spending; whether credit tightness will affect sectors other than housing, including the household sector and commercial real estate; and whether the labor market will continue to slow. There is a general view that downside risks to output have increased with some very bad scenarios at least conceivable. However, others noted the resilience of the U.S. economy and the fact that previous financial crises had not necessarily reduced growth. Inflation has moderated somewhat, and more participants view the risk to inflation as closer to balance. Inflation expectations remain stable, and cyclical slowing is likely to reduce the pressure on resources. However, tight labor markets, strong foreign demand, high oil prices, and other pressures still do exist. Are there any questions or comments? Let me just make, as I said, a few extra comments here. More so than usual, we have to look forward rather than backward. We have to try to assess how these recent developments change the outlook, and that is very difficult. To me, the critical elements to look at are housing and labor markets. I think the interaction of those two sectors will determine the dynamics of the economy. There has been some discussion about the fact that in 1998 there was very little effect of the financial markets on the real economy. There was no obvious channel of effect in that episode. In this case, there is, I think, a pretty clear channel of effect through mortgage lending, and we have already seen changes in availability of mortgages and changes in cancellations, sales expectations, and the like. I would note that there are also—as you can see in the consumer confidence numbers, for example—expectations on the buyer side. If buyers think that the housing market is going to be very weak, they will be less likely to want to get into it. Finally, credit availability to homebuilders may also be an issue. So I think there is pretty much a consensus that the housing sector will take another leg down based on financial market conditions. I mention parenthetically that I have some concerns also about a few other areas, notably commercial real estate, and perhaps others like consumer credit and autos as well; but, again, I think the focus should be on housing. On the labor side, I think we can parse the job report numbers in some detail. For example, on the one hand, the August report was not quite as weak as the markets thought it was. On the other hand, it revised down some previous numbers. So overall there seems to be a sense that labor markets were slowing a bit before the financial crisis. Even so, we have been expecting weakening in labor markets for some time, and I think now that the odds of that are really quite high. I do expect to see continued expansion in construction layoffs. There are losses of jobs, obviously, in mortgage finance and other related areas. So I don’t know how quickly the labor market will weaken, but I do believe that it will weaken over the next couple of quarters. Now, those are two predictions. Then the question is, What is the interaction between those two things? I think there is potential for a negative feedback cycle, which is of some concern. If labor markets weaken, particularly if they weaken severely in certain local areas, it will hurt house prices through two mechanisms. First, house prices capitalize employment and other economic opportunities in an area, so house prices will fall as economic activity slows. Second, the demand for housing or the ability to make house payments directly depends on labor income. Working in the other direction, as house prices fall, the normal wealth effects, but also possible precautionary saving effects or other liquidity effects, could begin to affect consumer confidence and consumer spending, and we get the makings of a potential recessionary dynamic that may be difficult to head off. That is the scenario that concerns me. I don’t know if it’s the modal scenario, but I think it’s one we need to watch very carefully. Beyond that scenario, there are further tail risks. As a number of people have mentioned, most recently Governor Mishkin, these financial effects—financial accelerator effects, if you will—can be quite nonlinear. The Greenbook has a 2 percent decline in house prices in each of the next two years. It’s very possible that the decline could be greater than that. Even if it’s not greater than that, it will not be uniformly distributed around the country. In some parts of the country, house price declines will be much more significant. The nonlinearity I’m talking about has to do with the distribution of equity among families. If you have a 10 percent decline in house prices and two families, each of which has 50 percent equity in their home, then each family is going to experience basically the normal wealth effect. But if one family has 100 percent equity and the other has 5 to 10 percent equity, the effects on behavior will not be linear. There will be a bigger effect on the family that finds itself in financial stress, and the possibility exists that weakening in these markets could feed back into some of the financial problems we are seeing. So I am concerned about getting ahead of what could be an adverse dynamic between the job market and the housing market. On inflation, I think the slowing that we are likely to see will probably remove some of the upside risk that we have been concerned about. I don’t know how these housing developments will affect owners’ equivalent rent. We saw some perverse effects last time. They are still possible. A very small piece of information is that the PPI numbers yesterday actually had some favorable news in them in terms of both intermediate goods and medical costs. So the near term still looks to be fairly good. But I don’t dismiss inflation risks by any means, and we know that policy changes can work through expectations as well as through resource pressure, and so I consider that to be a serious concern. Nevertheless, I do at this point think the principal risks are to the downside, and the interaction between different components of the economy presents the biggest challenge in that respect. I will stop there. Brian, if you are ready to introduce the policy alternatives now." CHRG-111hhrg55811--52 Mr. Hu," Well, in terms of that issue, right now there is a distinction, for instance, between broad-based security-based swaps and narrowly-based security swaps. Broad-based security swaps basically fall under the jurisdiction of the CFTC, while security-based swaps and narrow-based security swaps fall under the jurisdiction of the SEC. We feel that because of the arbitrage possibilities from using two broad-based security-based swaps to get targeted exposure to a single company or a narrow group of companies, that it allows for easy gaming. By simplifying things to treat, for instance, all security-based swaps as securities and falling within the parameters of the Federal securities laws simplifies matters, reduces the possibility of gaming of gaps, and facilities more efficient responses. " CHRG-111shrg56415--81 PREPARED STATEMENT OF JOHN C. DUGAN * Comptroller of the Currency Office of the Comptroller of the Currency October 14, 2009--------------------------------------------------------------------------- * Statement Required by 12 U.S.C. Sec. 250: The views expressed herein are those of the Office of the Comptroller of the Currency and do not necessarily represent the views of the President.---------------------------------------------------------------------------I. Introduction Chairman Johnson, Senator Crapo, and members of the Subcommittee, I am pleased to testify on the current condition of the national banking system, including trends in bank ending, asset quality, and problem banks. The OCC supervises over 1,600 national banks and Federal branches, which constitute approximately 18 percent of all federally insured banks and thrifts, holding just over 61 percent of all bank and thrift assets. These nationally chartered institutions include 15 of the very largest U.S. banks, with assets generally exceeding $100 billion; 23 mid-sized banks, with assets generally ranging between $10 billion and $100 billion; and over 1,500 community banks and trust banks, with assets between $1.5 million and $10 billion. The OCC has dedicated supervisory programs for these three groups of institutions that are tailored to the unique challenges faced by each. My testimony today makes three key points. First, credit quality is continuing to deteriorate across almost all classes of banking assets in nearly all sizes of banks. As the economy has weakened, the strains on borrowers that first appeared in the housing sector have spread to other retail and commercial borrowers. For some credit portfolio segments, the rate of nonperforming loans is at or near historical highs. In many cases, this declining asset quality reflects risks that built up over time, and while we may be seeing some initial signs of improvement in some asset classes as the economy begins to recover, it will generally take time for problem credits to work their way through the banking system. Second, the vast majority of national banks are strong and have the financial capacity to withstand the declining asset quality. As I noted in my testimony last year before the full Committee, we anticipated that credit quality would worsen and that banks would need to further strengthen their capital and loan loss reserves.\1\ Net capital levels in national banks have increased by over $186 billion over the last 2 years, and net increases to loan loss reserves have exceeded $92 billion. While these increases have considerably strengthened national banks, we anticipate additional capital and reserves will be needed to absorb the additional potential losses in banks' portfolios. In some cases that may not be feasible, however, and as a result, there will continue to be a number of smaller institutions that are not likely to survive their mounting credit problems. In these cases we are working closely with the FDIC to ensure timely resolutions in a manner that is least disruptive to local communities.--------------------------------------------------------------------------- \1\ Testimony of John C. Dugan before the Committee on Banking, Housing, and Urban Affairs, United States Senate, June 5, 2008, page 2.--------------------------------------------------------------------------- Third, during this stressful period we are extremely mindful of the need to take a balanced approach in our supervision of national banks, and we strive continually to ensure that our examiners are doing just that. We are encouraging banks to work constructively with borrowers who may be facing difficulties and to make new loans to creditworthy borrowers. And we have repeatedly and strongly emphasized that examiners should not dictate loan terms or require banks to charge off loans simply due to declines in collateral values. Balanced supervision, however, does not mean turning a blind eye to credit and market conditions, or simply allowing banks to forestall recognizing problems on the hope that markets or borrowers may turn around. As we have learned in our dealings with problem banks, a key factor in restoring a bank to health is ensuring that bank management realistically recognizes and addresses problems as they emerge, even as they work with struggling borrowers.II. Condition of the National Banking System: Credit Quality Has Replaced Liquidity as Major Concern Beginning in the fall of 2007 and extending through the first quarter of this year, bank regulators and the industry were confronted with unprecedented disruptions in the global financial markets. In the wake of severe problems with subprime mortgages, the value of various securitized assets and structured investment products declined precipitously. Key funding and short term credit markets froze, sparking a severe contraction in the liquidity that sustains much of our economy and banking system, including uninsured deposit funding. The combination of these events led to failures, government assistance, and government takeover of several major financial institutions. Through the collective efforts and programs resulting from actions taken by Congress, the Treasury Department, the Federal Reserve Board, the Federal Deposit Insurance Corporation, and governments around the world, there has been significant stabilization in credit and funding markets for all financial institutions, including banks of all sizes. As reflected in both the TED and Libor-OIS spreads,\2\ each of which has fallen to less than 20 basis points after peaking at well over 300 basis points during the crisis, the interbank funding market has vastly improved, with banks once again willing to extend credit to counterparties. There has also been a slight rebound in certain securitization markets. For example, non-mortgage asset-backed securities issuance for 2Q:2009 totaled $49 billion, up 121 percent from 1Q:2009. Similarly, syndicated market loan issuances increased to $156 billion in 2Q:2009, up 37 percent from 1Q:2009.--------------------------------------------------------------------------- \2\ The TED spread reflects the difference between the interest rates on interbank loans in the Eurodollar market and short-term U.S. Government Treasury bills. The OIS is the overnight indexed swap rate. Both spreads are a measure of how markets are viewing the risks of financial counterparties.--------------------------------------------------------------------------- The drag on national banks' balance sheets and earnings from the overhang of various structured securities products has been very significantly reduced due to the substantial write-downs that banks took on these assets in 4Q:2008 and 1Q:2009 and the overall recovery in credit markets. Losses sustained at our 10 largest banking companies for these securities reached $44 billion in 2008, but dropped to $8 billion in 1Q:2009 and $1 billion in 2Q:2009. There are some banks that still face strains in their investment portfolios, largely due to their holding of certain private label mortgage-backed and trust preferred securities. While most banks will be able to absorb the losses that may arise from these holdings, there is a small population of banks that have significant concentrations in these products that we are closely monitoring. We expect these banks will continue to take incremental credit impairments through earnings until mortgage metrics improve. In my financial condition testimony before the full Committee last year, I observed that, as market conditions began to stabilize, the focus of supervisors and bankers would increasingly turn to the more traditional challenges of identifying and managing problem credits.\3\ That has indeed proven to be the case, as declining asset quality has become the central challenge facing banks and supervisors today. While there recently have been some signs of economic recovery, data through the second quarter of this year demonstrate that asset quality across the national bank population significantly deteriorated over the preceding twelve months, as both retail and commercial borrowers remained under stress from job losses and the overall contraction in the economy. The percentage of noncurrent loans (loans that are 90 days or more past due or on nonaccrual) increased dramatically and reached the highest level in at least twenty 5 years (see Chart 1).--------------------------------------------------------------------------- \3\ Testimony of John C. Dugan before the Committee on Banking, Housing, and Urban Affairs, United States Senate, June 5, 2008, page 9. In addition, the rate at which banks are charging off loans has also accelerated and, for some portfolio segments, now exceeds previous peaks experienced during the last credit cycle. Continued concerns about the economy are also affecting loan growth and demand as businesses, consumers, and bankers themselves retrench on the amount of leverage and borrowing they want to assume. As a result, loan growth through 2Q:2009 has slowed across the national bank population and in various portfolio segments. (See charts 2 and 3) A number of factors are evident for this decline in credit, including the following: Reduction in loan demand, as reductions in consumer spending have caused businesses to cut back on inventory and other investments; Reduction in the demand for credit from borrowers who may have been able to afford or repay a loan when the economy was expanding, but now face constrained income or cash-flow and debt service capacity; Reductions in loan demand as households work to rebuild their net worth, as reflected in the increased U.S. savings rate; Actions taken by bankers to scale back their risk exposures due to weaknesses in various market and economic sectors, and to strengthen underwriting standards and loan terms that had become, in retrospect, too relaxed. In addition, many banks have increasingly shifted their focus and resources to loan collections, workouts, and resolutions, and some troubled banks have curtailed lending due to funding and capital constraints; and Continued uncertainty on the part of borrowers and lenders about the strength and speed of the economic recovery in many regions of the country. As demonstrated in chart 4 below, businesses have significantly reduced their investments and inventories and, in an effort to strengthen their own balance sheets, many larger businesses have replaced short-term borrowing with longer-term corporate bond issues. Similarly, chart 5 shows that consumers are repairing their personal balance sheets with significant increases in their personal savings rates. This interplay of factors and their effects on lending are consistent with our recent annual underwriting survey and the Federal Reserve Board's most recent Senior Loan Officer Survey. OCC examiners report that the financial market disruption continues to affect bankers' appetite for risk and has resulted in a renewed focus on fundamental credit principles by bank lenders. Our survey indicates that primary factors contributing to stronger underwriting standards are bankers' concerns about unfavorable external conditions and product performance.\4\ In its July Senior Loan Officer Survey, the Federal Reserve reported that ``demand for loans continued to weaken across all major categories except for prime residential mortgages.''\5\--------------------------------------------------------------------------- \4\ OCC Survey of Underwriting Practices 2009, page 3. \5\ Board of Governors of the Federal Reserve System, ``The July 2009 Senior Loan Officer Survey on Bank Lending Practices,'' page 1.--------------------------------------------------------------------------- Some have also suggested that unnecessary supervisory actions may have significantly contributed to the decline in credit availability. While I do not believe the evidence supports this suggestion, I do believe, as addressed in more detail at the end of this testimony, that it is critical for supervisors to stay focused on the type of balanced supervision that is required in the stressful credit conditions prevalent today. Finally, the combination of deteriorating credit quality, lower yields on earning assets, and slower loan growth is the primary factor currently affecting national banks' earnings. As shown in Chart 6, there has been a marked deterioration in the return on equity across the national banking population as modest increases in banks' net interest margins due to more favorable costs of funds have failed to offset credit quality problems and the continued need for banks to build loan loss reserves.III. Trends in Key Credit Portfolios and Capital and Reserve Positions Against this backdrop, let me now describe trends in major credit segments and in capital and loan loss reserve levels.A. Retail Credit Although retail loans--mortgages, home equity, credit cards, and other consumer loans--account for just over half of total loans in the national banking system, they currently account for two-thirds of total losses, delinquencies, and nonperforming credits. To a large extent, however, these problems are confined to the largest 15 national banks, which hold almost 91 percent of retail loans in the national banking system.1. First and Second Mortgages The residential mortgage sector was the epicenter of the financial turmoil and continues to figure prominently in the current condition of the banking industry. As the economy has worsened, problems that started in the subprime market have spread to the so-called ``Alt A'' market, and increasingly, to the prime market. While over-leverage and falling housing prices were the initial drivers of delinquencies and loan losses, borrower strains resulting from rising unemployment and underemployment are an increasingly important factor. In the first mortgage market, the June 30, 2009 Mortgage Bankers Association's National Delinquency Survey shows continued growth in foreclosure inventory, but a relatively flat rate of new foreclosure starts overall between the first and second quarter of this year. The rate of prime foreclosures, however, continues to increase, with starts at about 1 percent of the surveyed population as of the end of the second quarter. Although this percentage is still relatively small, the impact is significant given the much larger size of the prime market segment compared to the markets for subprime and Alt-A loans. While it is true that many first mortgages were sold to third party investors via the securitization market, and the loan quality of such mortgages retained by banks is generally higher than those sold to third parties, it nevertheless remains the case that a number of larger banks have significant on-balance sheet exposure to first mortgage losses from portfolios that continue to deteriorate. The same is true of second mortgages--home equity loans and lines of credit--except that the overwhelming majority of these loans reside on bank balance sheets. There were some positive signs in the second quarter showing home equity loan delinquency rates falling, and the pace of increase in second lien charge-off rates slowing. But the hard fact is that losses on these loans through the first half of this year nearly equaled total losses for all of 2008, and loss rates are expected to continue to climb--though at a slower rate--through at least the middle of 2010. In short, deterioration in the first and second residential mortgage markets continue to dominate the credit quality performance in national banks' retail portfolios, as it has since the second half of 2008. Total delinquent and nonperforming residential real estate loans (mortgage and home equity) in national banks now hover around 9.4 percent, with a loss rate of just over 2.5 percent--the highest level since we have been collecting this data. There have been some positive indicators in the housing market in recent months that could slow the pace of losses in residential mortgages, including increased home sales in June and July, and slight increases in the Case-Shiller composite index for certain metropolitan areas. While these signs are encouraging, it is too early to determine whether they signal a true turning point in this sector. For example, the increase in home sales this summer is consistent with seasonal trends and may not be sustainable. In addition, sales may be enjoying a temporary boost from the First-Time Homebuyer Tax Credit program which, unless extended, will end in November. Much will depend, of course, on the extent to which economic recovery takes hold and truly stabilizes the housing market. In terms of mortgage modifications, all of the major national bank mortgage servicers are actively participating in the Administration's Making Home Affordable Program. Servicers have been significantly expanding their staff levels in the loss mitigation/collection areas--doubling and tripling customer contact personnel, and requiring night and weekend overtime work. Servicers have also been ramping up their training efforts, customer service scripts, and automated qualification and underwriting systems to improve the processing of loan modification requests. The OCC is closely monitoring these and other home modification efforts through onsite examinations and other ongoing supervisory initiatives, as well as through our Mortgage Metrics quarterly reporting program. And examiners continue to monitor modification programs for compliance with all applicable fair lending and consumer compliance laws. Our latest Mortgage Metrics report shows that actions to keep Americans in their homes grew by almost 22 percent during 2Q:2009.\6\ Notably, the percentage of modifications that reduced borrowers' monthly principal and interest payments continued to increase to more than 78 percent of all new modifications, up from about 54 percent in the previous quarter. We view this as a positive development, as modifications that reduce borrowers' monthly payments generally produce lower levels of re-defaults and longer term sustainability than modifications that either increase payments or leave them unchanged.--------------------------------------------------------------------------- \6\ See OCC News Release 2009-118, September 30, 2009.---------------------------------------------------------------------------2. Credit Cards Credit card performance began to deteriorate sharply in the latter part of 2008 and has continued to weaken further this year, with record levels of losses and delinquencies. As with second lien mortgages, there have been some encouraging signs recently in the form of declining early stage delinquency rates, but loss rates continue to climb. As of June 30, the overall loss rate was 10.3 percent for national banks, and more recent data shows continued deterioration-with industry analysts predicting even higher loss rates into 2010. In response to these trends and the overall deterioration in the economy, many credit card issuers are adjusting their account management policies to reflect and respond to the increased risk in these accounts. In some cases these actions have resulted in credit lines being reduced or curtailed. In other cases, they have led to increased interest rates, effectively increasing the minimum payment to cover the higher finance charges. In still other cases they have resulted in an increase in minimum payments to extinguish the outstanding debt more quickly. Many credit card issuers are also re-evaluating certain credit card product features, such as ``no annual fees'' or various reward programs, and are offering cards with simpler terms and conditions, in part due to the recently enacted Credit CARD Act. We are monitoring these changes in credit card account terms to ensure that they comply with all applicable limit and notice requirements, including those mandated by the Credit CARD Act. For example, in July we notified national banks that, effective August 22, 2010, they must conduct periodic reviews of accounts whose interest rates have been increased since January 1, 2009, based on factors including market conditions and borrower credit risk. More recently, we issued a bulletin advising national banks abut the interim final rules issued by the Federal Reserve under the Credit CARD Act that became effective on August 20, 2009. The Federal Reserve's rules require lenders to notify customers 45 days in advance of any rate increase or significant changes in credit card account terms and to disclose that consumers can have the right to reject these changes. Under the rules, the new rates or terms can be applied to any transaction that occurs more than 14 days after the notice is provided--even if the customer ultimately rejects those terms. To address the risk of consumer confusion, the OCC directed national banks to include an additional disclosure not required by the rules to alert consumers, if applicable, to the imposition of the new terms on transactions that occur more than 14 days after thenotice is provided, regardless of whether the consumer rejects the change and cancels the account. As with residential mortgages, we are encouraging national banks to work with consumers who may be facing temporary difficulties and hardships, and more banks are reaching out to assist customers before they become delinquent. Banks have a number of viable default management options to assist in this endeavor, although it is important that, as they do so, they continue to appropriately account for losses as they occur. Card issuers are also reevaluating the size of unused credit lines in response to current credit conditions, recent regulatory changes, and recent adoption by the Financial Accounting Standards Board (FASB) of two new accounting standards, Statement No. 166, Accounting for Transfers of Financial Assets--an amendment of FASB Statement No. 140 (FAS 166) and Statement No. 167, Amendments to FASB Interpretation No. 46(R) (FAS 167). These standards become effective for an entity's first fiscal year beginning after November 15, 2009, and will have a significant impact on many banking institutions. In particular, many securitization transactions, including credit card securitizations, will likely lose sales accounting treatment, prompting the return of the securitized assets to banks' balance sheets. Although we are still evaluating the impact of these changes, we anticipate that they will have a material effect on how banks structure transactions, manage risk, and determine the levels of loan loss reserves and regulatory capital they hold for certain assets, including credit cards. The net effect of these changes is that banks will most likely face increased funding and capital costs for these products. The combination of all these factors has resulted in a decline in overall credit card debt outstanding and--especially--overall unfunded credit card commitments, reflecting pullbacks by both consumers and lenders. For national banks, managed card outstandings (i.e., funded loans both on and off banks' balance sheets) declined by 4 percent thus far this year, or roughly $27 billion. Unfunded credit card commitments (lines available to customers) have declined more precipitously, by 14.8 percent or $448 billion. These trends are consistent with overall industry data. In summary, retail credit quality issues continue to be an area of concern, especially for the larger national banks. Although there are some early signs of delinquency rates declining, with some bankers telling us they are beginning to see adverse trends leveling off, sustained improvements in this sector will largely depend on the length and depth of the recession and levels of unemployment.B. Commercial and Industrial Loans The fallout from the housing and consumer sectors to other segments of the economy is evident in the performance of national banks' commercial and industrial (C&I) loan portfolios. Adverse trends in key performance measures, including 30-day or morepast due delinquencies, non-performing rates, and net loss rates, sharply accelerated in the latter part of last year and have continued to trend upward in 2009. For example, the percentage of C&I loans that are delinquent or nonperforming has risen from a recent historical low of 1.02 percent in 2Q:2007 to 3.90 percent in 2Q:2009. Although this is the highest rate since the ratio peaked at 4.15 percent in 2Q:2002 during the last recession, it is still well below the 1991 recession peak of 6.5 percent. In contrast to retail loans, which primarily affect the larger national banks, the effect of adverse trends in C&I loans is fairly uniform across the national bank population. This segment of loans represents approximately 20 percent of total loans in the national banking system, with levels somewhat more concentrated at larger institutions than at community banks, where C&I loans account for approximately 16 percent of total loans. While credit quality indicators are marginally worse at the larger national banks, the trend rate and direction are fairly consistent across all sizes of national banks. One measure of C&I loan quality comes from the Federal banking agencies' Shared National Credit (SNC) program, which provides an annual review of large credit commitments that cut across the financial system. These large loans to large borrowers are originated by large banks, then syndicated to other banks and many types of nonbank financial institutions such as securitization pools, hedge funds, insurance companies, and pension funds.\7\ This year's review, which was just recently completed, also found sharp declines in credit quality. The review, which covered 8,955 credits totaling $2.9 trillion extended to approximately 5,900 borrowers, found a record level of $642 billion in criticized assets--meaning loans or commitments that had credit weaknesses--representing approximately 22 percent of the total SNC portfolio. Total loss of $53 billion identified in the 2009 review exceeded the combined loss of the previous eight SNC reviews and nearly tripled the previous high in 2002. Examiners attributed the declining credit quality to weak economic conditions and the weak underwriting standards leading up to 2008.\8\--------------------------------------------------------------------------- \7\ In fact, nonbanks hold a disproportionate share of classified assets compared with their total share of the SNC portfolio, owning 47 percent of classified assets and 52 percent of nonaccrual loans, whereas FDICinsured institutions hold only 24.2 percent of classified assets and 22.7 percent of nonaccrual loans. \8\ See OCC News Release 2009-11, September 24, 2009.---------------------------------------------------------------------------C. Commercial Real Estate Loans The greatest challenge facing many banks and their supervisors is the continued deterioration in commercial real estate loans (CRE). There are really two stories here, with one related to the other. The first involves residential construction and development (C&D) lending, especially with respect to single family homes. Not surprisingly, given the terrible strains in the housing sector over the last 2 years, delinquency rates have already climbed tohigh levels, with significant losses already realized and more losses continuing to work their way through the banking system. For national banks as of June 30, total delinquent and nonperforming rates were at just over 34 percent in the largest national banks; 23.4 percent in mid-size banks; and 17.5 percent in community banks. The relative size of these loss rates is somewhat misleading, however, because many community banks and some mid-size banks have much greater concentrations in residential C&D loans than the largest banks. As a result, the concentrated losses in these smaller institutions has had a much more pronounced effect on viability, with concentrated residential C&D lending constituting by far the single largest factor in commercial bank failures in the last two years. At this point in the credit cycle, we believe the bulk of residential C&D problems have been identified and are being addressed, although a number will continue to produce losses that result in more bank failures. The second story involves all other types of commercial real estate loans, including loans secured by income producing properties. Credit deterioration has spread to these assets as well, and trend lines are definitely worsening, but thus far the banking system has not experienced anywhere near the level of delinquency and loss as it has in C&D lending. Still, the signs are troubling. Declining real estate values caused by rising vacancy rates, increasing investor return requirements, falling rental rates, and weak sales are affecting all CRE segments. For example, Property and Portfolio Research reports that apartment vacancy rates have hit a 25-plus year high at 8.4 percent nationally, and there are similar patterns for retail, office, and warehouse space as demand falls across all segments. But unlike the CRE markets in 1991, much of the current fallout is driven more by a decrease in demand than from an oversupply of properties. The outlook for these markets over the near term, especially for the income producing property sector, is not favorable. In general, deterioration in performance for these CRE loans lags the economy as borrowers' cash-flows may be sufficient during the early stages of a downturn, but become increasingly strained over time. There are alsogrowing concerns about the refinancing risk within the commercial mortgage-backed securities market (CMBS) where there is a currently moderate-but-growing pipeline of loans scheduled to mature. Permanent or rollover refinancing of these loans may be difficult due to the declines in commercial property values coupled with the return to more prudent underwriting standards by both lenders and investors. While this is an area that we are monitoring, the largest proportion and more problematic of these mortgages will not mature until 2011 and 2012. As with C&I loans, trends in total delinquent and nonperforming CRE rates (including C&D loans) have been fairly consistent across all segments of the national bank population, climbing to roughly 8.3 percent in 2Q:2009. While C&D losses will continue to be most problematic for the banks that have the largest concentrations in these assets, theextent to which other types of CRE loan losses will continue to climb will depend very much on the overall performance of the economy.D. Capital and Reserve Levels Perhaps the most critical tools for dealing with and absorbing credit losses are substantial levels of capital and reserves. As a result, in anticipation of rising credit losses over the last 2 years, the OCC has directed banks to build loan loss reserves and strengthen capital. In aggregate, the net amount of capital in national banks (i.e., the net increase after items such as losses and dividends and including capital as a result of acquisitions and net TARP inflows) has risen by over $186 billion over the last 2 years, and the net build to loan loss reserves (i.e., loan loss provisions less net credit losses) has been over $92 billion. These increases in loss-absorbing resources are critical contributors to the overall health of the national banking system. As illustrated by the dotted line in the chart below, the level of reserves to total loans in the national banking system has increased dramatically to a ratio of 3.3 percent, the highest in over 25 years. While such high reserves are imperative for dealing with the high level of noncurrent loans, the solid line in the chart below shows that more provisions may be needed, because the ratio of reserves to noncurrent loans has continued to decline, to under 100 percent--reflecting the fact that the substantial growth in reserves is not keeping pace with the even greater growth in noncurrents. Substantially building reserves at the same time as credit conditions weaken is often described as unduly ``pro-cyclical,'' because bank earnings decline sharply from provisioning well before charge-offs actually occur. That is certainly an accurate characterization under the current accounting system for loan loss reserving, although there will always be a need to build reserves to some extent as credit losses rise. The issue is really about how much; that is, if reserve levels are high going into a credit downturn, then the need to build reserves is far lower than it is when the going-in levels are low. Unfortunately, our current accounting standards tend to produce very low levels of reserves just before the credit cycle turns downward, especially after prolonged periods of benign credit conditions as we had in the first part of this decade. In such periods, the backward-looking focus of the current accounting model creates undue pressure to decrease reserve levels even where lenders believe the cycle is turning and credit losses will clearly increase. I strongly believe that a more forward looking accounting model based on expected losses would both more accurately account for credit costs and be less pro-cyclical. This is an issue that I have been working on as co-chair of the Financial Stability Board's (FSB) Working Group on Provisioning, and I continue to be hopeful that accounting standard setters will embrace this type of change as they consider adjustments to loan loss provisioning standards.IV. Most National Banks Have Capacity to Weather This Storm The credit conditions I have just described are stark and will require considerable skills by bankers and regulators to work through. Despite these challenges, I believe the vast majority of national banks are and will continue to be sound, and that they have the wherewithal to manage through this credit cycle. Notwithstanding the negative trends and earnings pressures that banks are facing, we should not lose sight that, as of June 30, 2009,97 percent of all national banks satisfied the required minimum capital standards to be considered well capitalized, and 76 percent reported positive earnings. As previously described, the OCC has separate supervisory programs for Large Banks (assets generally exceeding $100 billion); Mid-Sized Banks (assets from $10 billion to $100 billion); and Community Banks (assets below $10 billion). Let me summarize our general assessment of the condition of each group.A. Large Banks In some respects, large banks faced the earliest challenges, with the disruptions in wholesale funding markets, the significant losses they sustained on various structured securities. and the pronounced losses that emerged earlier in their retail credit portfolios. As I mentioned, there are some preliminary indicators that the rate of increased problems in the retail sector may have begun to slow, but as with credit conditions in general, much of this will depend on the timing and strength of the economy, and in particular, on unemployment rates. C&I and CRE loan exposures remain a concern for these banks, but they have more diversified portfolios and exposures than many smaller banks and thus may be in a better position to absorb these problems. Collectively, the fifteen banks in our Large Bank program raised $132 billion in capital (excluding TARP funding) in 2008 and, over the past twenty 4 months, their net build to loan loss reserves totaled approximately $85 billion. Earlier this year we and the other Federal regulators conducted a detailed stress test of the largest U.S. banks as part of the Supervisory Capital Assessment Program (SCAP) to examine their ability to withstand even further deterioration in market and credit conditions. I believe that was an extremely valuable exercise for four reasons. First, the one-time public assessment of individual institution supervisory results--which was only made possible by the U.S. Government backstop made available by TARP funding--alleviated a great deal of uncertainty about the depth of credit problems on bank balance sheets, which a number of analysts had assumed to be in far worse condition. Second, the reduction of uncertainty allowed institutions to access private capital markets to increase their capital buffer for possibly severe future losses, instead of requiring more government capital. Third, the additional capital required to be raised or otherwise generated now--over $45 billion in common stock alone has already been issued by the nine SCAPinstitutions with national bank subsidiaries--provides these banks with a strong buffer to absorb the severe losses and sharply reduced revenue associated with the adverse stress scenario imposed under SCAP for the 2-year period of 2009 and 2010, should that scenario come to pass. Fourth, as we track banks' actual credit performance against the SCAP adverse stress scenario to ensure that capital levels remain adequate, we have found that, through the first half of 2009--which constitutes 25 percent of the overall 2-year SCAP stress period--actual aggregate loan losses were well below 25 percent of the aggregate losses projected for the full SCAP period, and actual aggregate revenues were well above 25 percent of the aggregate projected SCAP revenues. While those trends could change as the stress period continues, the early results are promising.B. Mid-Size Banks Although mid-size national banks engage in retail lending, the scope and size of their exposures are not as significant as those of the largest national banks. Mid-size banks also did not have the significant losses that larger banks did from various structured investment products. Nevertheless, loan growth at these banks turned negative in 2Q:2009, and although they experienced modest improvements in net interest margins in the second quarter, they still face downward earnings pressures, primarily due to increasing loan loss provisions. Given their exposures to the C&I and CRE markets, we expect these pressures will persist, notwithstanding the $3.5 billion in net reserve builds over the last twenty four months. These banks have also had success in attracting new capital, raising close to $5 billion thus far this year.C. Community Banks Nearly all national community banks entered this environment with strong capital bases that exceeded regulatory minimums. As a group, they have been less exposed to problems in the retail credit sector that have confronted large and mid-size banks, and the vast majority of these banks remain in sound financial condition. As noted earlier, there is a small number of community banks that have concentrations in trust preferred and private label mortgage-backed securities that we are closely monitoring. Of more significance are the exposures that many community banks have to commercial real estate loans. As I noted in my June 2008 testimony, we have been concerned for some time about the sizable concentrations of CRE loans found at many smaller national banks. While national banks of all sizes have significant CRE exposures, as shown in Chart 8, CRE concentrations are most pronounced at community and mid-size banks. Because of this, the OCC began conducting horizontal reviews of banks with significant concentrations about 5 years ago. As credit conditions worsened, our efforts intensified in banks that we believed were at high risk from downturns in real estate markets. Our goal has been to work with bankers to get potential CRE problems identified at an early stage so that bank management can take effective remedial action. In most but not all cases, bank management teams are successfully working through their problems and have adequate capital and stable funding bases to weather additional loan losses and earnings pressures.V. Resolution of Problem Banks Given the strains in the economy and banking system, it is not surprising that the number of problem banks has increased from the recent historical lows. In the early 1990s, the number of problem national banks--those with a CAMELS composite rating of 3, 4 or 5--reached a high of 28 percent of all national banks. Thereafter, the number of problem national banks relative to all national banks dropped dramatically and then fluctuated in a range of three to 6 percent until 2007. Since then, however, the number of problem banks has risen steadily, and it is now approximately 17 percent of national banks. As would be expected, this upward trend in problem banks also has resulted in an increased number of bank failures. In January, 2008, we had the first national bank failure in almost 4 years, the longest period without a failure in the 146-year history of theOCC. That began the current period of significantly increased failures. In total, since January 1 of 2008, there have been 123 failures of insured banks and thrifts. Of these, 19 have been national banks, accounting for 11 percent of the total projected loss to thedeposit insurance fund from all banks that failed during this period. All of the 19 failed national banks have been community banks, although the total obviously does not include the two large bank holding companies with lead national banks that were the subject of systemic risk determinations and received extraordinary TARP assistance on an open-institution basis. While the vast majority of national banks have the financial capacity and management skills to weather the current environment, some will not. Given the real estate concentrations in community banks, the number of problem banks, the severe problems in housing markets, and increasing concern with CRE, we expect more bank failures in the months ahead. Some troubled banks will be able to find strong buyers--in some instances with our assistance--that will enable them to avoid failure and resolution by the FDIC. But that will not always be possible. When it is not, our goal, consistent with the provisions of the Federal Deposit Insurance Corporation Improvement Act, is to effect early and least cost resolution of the bank with a minimum of disruption to the community.VI. OCC Will Continue to Take a Balanced Approach in Our Supervision of National Banks Finally, I want to underscore the OCC's commitment to provide a balanced and fair approach in our supervision of national banks as bankers work through the challenges that are facing them and their borrowers. We recognize the important roles that credit availability and prudent lending play in our nation's economy, and we are particularly aware of the vital role that many smaller banks play in meeting the credit needs of small businesses in their local communities. Our goal is to ensure that national banks can continue to meet these needs in a safe and sound manner. I have heard some reports that bankers are receiving mixed messages from regulators: on one hand being urged to make loans to creditworthy customers, while at the same time being subjected to what some have characterized as ``overzealous'' regulatory examinations. In this context, let me emphasize that our messages to bankers have and continue to be straight-forward: Bankers should continue to make loans to creditworthy borrowers; But they should not make loans that they believe are unlikely to be repaid in full; and They should continue to work constructively with troubled borrowers--but recognize repayment problems in loans when they see them, because delay and denial only makes things worse. Let me also underscore what OCC examiners will and will not do. Examiners will not tell bankers to call or renegotiate a loan; dictate loan structures or pricing; or prescribe limits (beyond regulatory limits) on types or amounts of loans that a bank may make if the bank has adequate capital and systems to support and manage its risks. Examiners will look to see that bankers have made loans on prudent terms, based on sound analysis of financial and collateral information; that banks have sufficient risk management systems inplace to identify and control risks; that they set aside sufficient reserves and capital to buffer and absorb actual and potential losses; and that they accurately reflect the condition of their loan portfolios in their financial statements. Nevertheless, balanced supervision does not mean that examiners will allow bankers to ignore or mask credit problems. Early recognition and action by management are critical factors in successfully rehabilitating a problem bank. Conversely, the merepassage of time and hope for improved market conditions are not successful resolution strategies. We have taken a number of steps to ensure that our examiners are applying these principles in a balanced and consistent manner. For example, we hold both regular meetings and periodic national teleconferences with our field examiners to convey key supervisory messages and objectives. In our April 2008 nationwide call, we reviewed and discussed key supervisory principles for evaluating commercial real estate lending. In April of this year we issued guidance to our examiners on elements of an effective workout/restructure program for problem real estate loans. We noted that effective workouts can take a number of forms, including simple renewal or extension of the loan terms, extension of additional credit; formal restructuring of the loan terms; and, in some cases, foreclosure on underlying collateral. We further reiterated these key principles in a nationwide call with our mid-size and community bank examiners earlier this month. Through the FFIEC, we are also working with the other Federal and state banking agencies to update and reinforce our existing guidance on working with CRE borrowers and to help ensure consistent application of these principles across all banks. This guidance will reaffirm that prudent workouts are often in the best interests of both the bank and borrower and that examiners should take a balanced approach in evaluating workouts. In particular, examiners should not criticize banks that implement effective workouts afterperforming a comprehensive review of the borrower's condition, even if the restructured loans have weaknesses that result in adverse credit classification. Nor should they criticize renewed or restructured loans to borrowers with a demonstrated ability to repay, merelybecause of a decline in collateral values. Consistent with current policies, loans that are adequately protected by the current sound worth and debt service capacity of the borrower, guarantor, or the underlying collateral generally will not be classified. However, deferring issues for another day does not help the CRE sector or banking industry recover. It is important that bankers acknowledge changing risk and repayment sources that may no longer be adequate.VII. Conclusion I firmly believe that the collective measures that government officials, bank regulators, and many bankers have taken in recent months have put our financial system on a much more sound footing. These steps are also crucial to ensuring that banks will be ableto continue their role as lenders and financial intermediaries. Nonetheless, it is equally clear that there are still many challenges ahead, especially with regard to the significant deterioration in credit that both supervisors and bankers must work through. There are no quick fixes to this problem, and there is the real potential that, for a large number of banks, credit quality will get worse in the months ahead. Notwithstanding the significant loan loss provisions that banks have taken over the past 2 years, more may be needed as provisions and resulting loan loss reserves have not kept pace with the rapid increase in nonperforming assets. The OCC is firmly committed to taking a balanced approach as bankers work through these issues. We will continue to encourage bankers to lend and to work with borrowers. However, we will also ensure that they do so in a safe and sound manner and that they recognize and address their problems on a timely basis. ______ CHRG-111shrg50815--7 STATEMENT OF SENATOR SCHUMER Senator Schumer. I also have a moderately brief statement, like my colleague from across the Hudson River, but I thank you for calling on me. It is an issue that I have been involved with and care about for a long time. We know how important this is. Average credit card debt for the average--the average American family has $8,500 in credit card debt on a yearly income of $52,000. That ought to make you stop and think right then and there. I have been working on this issue for a long time. When I started in the 1980s, there were two schools. Some said disclosure is enough and competition would take hold. Others said, let us put limits. I was in the former school. I said, free market, let disclosure work. I worked long and hard on legislation and the Fed and the result was something that became known as the ``Schumer Box,'' clear, concise disclosures of important credit card terms in an easy-to-read table, and it worked. Before the Schumer Box, credit card interest rates were at 19.8 percent. Every company somehow came up with the conclusion that was the exact right rate. There was no competition. The box came in and rates came down. Good old fashioned American competition did the job. So it worked. Disclosures at that point seemed to be a good balance between consumer protection and fostering business and innovation. But now, credit card companies have become so clever at inducing consumers to buy and use cards and trapping them with high interest rates and fees that I believe disclosure is no longer enough. Over the past few years, we have seen explosion of debt. The card industry began using many of the same sales tactics as mortgage brokers, below-market fees or interest rates that shoot up for the most minor of infractions, and fine print, as Senator Menendez mentioned, containing dozens of fees that a consumer has to pay. Now, recently, the Federal Reserve updated the Schumer Box. I was glad to see that. But more has to be done. Consumers are trapped in a business model that is designed to induce mistakes and jack up fees. That sums it up. And then the fees go from 7 percent to 19 percent for some minor infraction on all the debt, something is very wrong and disclosure is not enough. The type of trip-wire pricing is predatory. It has to end. One issuer went so far as to provide its customers with incorrectly addressed return envelopes to ensure that consumer payments wouldn't arrive on time and allowed the company then to charge late payment fees. That is outrageous. Other companies charge fees so often, so many fees so often, borrowers end up paying over the limit fees because their credit has been maxed out by the previous round of fees, a vicious treadmill cycle. So as I said, the Fed has made a good step, but the rule, which doesn't go into effect until July 2010, that is too far from now. Too many families are struggling to make their minimum payment. And while the Fed's intentions are now good, we cannot be too shortsighted. There is going to come another time when credit will be loose and issuers will seek to roll back some of the important protections the Fed has implemented. That is why we must legislate. I have introduced the bill on the Senate side along with my friend, Senator Udall, that Congresswoman Maloney, my colleague, has introduced and successfully passed on the House side. And I know that Senator Dodd is considering many of the points in that legislation, as many of my other colleagues' legislation, when he puts together a bill, and I hope we will move one quickly, Mr. Chairman. Senator Johnson. Does anyone else feel absolutely compelled to make a comment? Senator Reed. Can I make a very, very, very brief comment? Senator Johnson. Senator Reed. CHRG-110shrg50414--112 Chairman Dodd," Thank you very much, Senator. Senator Schumer. Senator Schumer. Thank you, Mr. Chairman, and I thank all the witnesses. This is not an easy day. One of the things that I mentioned I want to focus on is taxpayers, and so I have a couple of questions in that regard, first to Secretary Paulson. One of the things I have thought about is whether we shouldn't create an insurance fund, similar to the FDIC, for the whole financial system. All firms over a certain size would pay, not small little community banks but everything else. They would pay a fee, not too onerous or too large, but over time it could help defray the costs of any losses we might suffer. It is the financial system that has the trouble and the taxpayers are bailing it out, as you say, in part because it will help the taxpayers. But why do the taxpayers have to do the whole thing? What would be your initial reaction--I am not asking for a commitment here--of some kind of broad FDIC that would help pay for some of these losses from financial institutions, as I said, above a certain size, whether they participate in the program or not? " CHRG-111hhrg48874--14 Mr. Gruenberg," Thank you, Mr. Chairman. Thank you for the opportunity to testify on behalf of the FDIC on the balance between increased credit availability and prudent lending standards. The FDIC is very aware of the challenges faced by financial institutions and their customers during these difficult economic times. Bankers and examiners know that prudent, responsible lending is good business and benefits everyone. Adverse credit conditions brought on by an ailing economy and stressed balance sheets, however, have created a difficult environment for both borrowers and lenders. Resolving the current economic crisis will depend heavily on creditworthy borrowers, both consumer and business, having access to lending. In response to these challenging circumstances, banks are clearly taking more care in evaluating applications for credit. While this more prudent approach to underwriting is appropriate, it should not mean that creditworthy borrowers are denied loans. As bank supervisors, we have a responsibility to assure our institutions, regularly and clearly, that soundly structured and underwritten loans are encouraged. While aggregate lending activity for FDIC-insured institutions fell in the fourth quarter of 2008, this decline was driven mostly by the largest banks, which reported a 3.4 percent fall in loan balances. In contrast, lending activity at community banks with assets under $1 billion actually increased by 1.5 percent. Community banks are playing an important role in the current stressful environment and appear to be benefiting from their reliance on traditional core deposit funding and relationship lending. Some have questioned whether bank supervisors are contributing to adverse credit conditions by overreacting to current problems in the economy and discouraging banks from making good loans. The FDIC understands the critical role that credit availability plays in the national economy and we balance these considerations with prudential safety and soundness requirements. Over the past year, through guidance, the examination process and other means, we have sought to encourage banks to maintain the availability of credit. We have also trained our examiners on how to properly apply this guidance at the institutions we supervise and how to conduct examinations and communicate their findings to bank management without infringing on bank management's day-to-day decisionmaking and relationships with customers. The FDIC has taken a number of recent actions specifically designed to address concerns about credit availability. On November 12th of last year, we joined with the other Federal banking agencies in issuing the ``Interagency Statement on Meeting the Needs of Creditworthy Borrowers.'' The statement encourages banks to continue making loans in their markets, work with borrowers who may be encountering difficulties, and pursue initiatives such as loan modifications to prevent unnecessary foreclosures. Recently, the FDIC hosted a roundtable discussion with banking industry representatives and Federal and State bank regulators focusing on how they can work together to improve credit availability. One of the important points that came out of the session was the need for ongoing dialogue between these groups as they work toward a solution to the current financial crisis. Toward this end, FDIC Chairman Bair announced last week that the FDIC is creating a new, senior level office to expand community bank outreach, and plans to establish an advisory committee to address the unique concerns of this segment of the banking community. On January 12th of this year, the FDIC issued a Financial Institution Letter advising insured institutions that they should track the use of their capital injections, liquidity support, and/or financing guarantees obtained through recent financial stability programs as part of a process for determining how these Federal programs improve the stability of the institution and contribute to lending to the community. Internally at the FDIC, we have issued guidance to our examiners for evaluating participating banks' use of funds received through the TARP Capital Purchase Program and the Temporary Liquidity Guarantee Program. Examination guidelines for the new Public/Private Investment Fund will be forthcoming. Banks should be encouraged to make good loans, work with borrowers who are experiencing difficulties whenever possible, avoid unnecessary foreclosures, and continue to ensure that the credit needs of their communities are fulfilled. In concert with other agencies, the FDIC is employing a range of strategies to ensure that credit continues to flow on sound terms to creditworthy borrowers. Thank you for the opportunity to testify. I would be happy to answer any questions. [The prepared statement of Vice Chairman Gruenberg can be found on page 97 of the appendix.] " CHRG-111shrg57709--47 Mr. Volcker," If they get in trouble, they are going to fail, and that will make their own financing more difficult, or less easy, and presumably in itself tend to contain their leverage. So between the oversight and their natural self-protective instincts, hopefully, knowing that they are not going to be saved, we reduce the chance of crisis. Senator Shelby. Dr. Volcker, one of the President's recent proposals is a limit on consolidation in the financial sector. In particular, the President proposal would, to quote from a White House press release, quote, place limits on the excessive growth of the market share of liabilities at the largest financial firms to supplement existing caps on the market share of deposits. Along those lines, I have three questions. First, could you elaborate on what constitutes excessive growth and on what particular liabilities restrictions will be imposed there? In other words, what would excessive growth be? This is important. " CHRG-111hhrg56776--278 Mr. Nichols," Congressman Foster, I think it was a perfect storm of activities, activities, conditions, behaviors, failures, in a lot of places. So like Chairman Bernanke pointed to two or three different factors, I even think it's broader than that. Certainly, the industry played a role in terms of internal controls and risk management; lack of mortgage origination standards; the role of credit rating agencies; even our trade imbalance, a lot of money coming in for yield, interest rate policy. There was a perfect storm of failures. People were overleveraged. Some Americans bit off more than they could chew. It was really--I don't think you could just point to one thing that led to the housing bubble. There were a lot of accelerates and a lot of contributors to it, but it's a dozen different factors all intertwined, in my humble opinion. " FOMC20071211meeting--94 92,MR. EVANS.," Thank you, Mr. Chairman. Coming out of our October meeting, I expected a period of subpar growth stretching into the middle of 2008. Since I was anticipating some soft data, it was not obvious to me that the outlook had worsened until later in the intermeeting period. A lot of the data that we have cited are financial items that are difficult to assess and are somewhat unusual for the current period. But the incoming information has caused us to mark down our outlook further, although we don’t see growth declining as far below potential as in the Greenbook baseline forecast. Although housing continues to weaken, that by itself did not cause a substantial revision to our outlook. The bigger factor was a noticeable weakening of consumption. PCE was basically flat in September and October—I guess dead on arrival. The financial headlines are taking their toll on consumer sentiment, and higher energy prices are lowering real incomes. It is not clear, however, that we are seeing a major sustained pullback in consumption; but, of course, that is arguable. The limited information we have about November—motor vehicle sales and the chain store data—suggest at least modest gains in consumer expenditures. I realize that the chain store sales could be a bit artificial. I was talking to one of my business contacts who has a significant presence in retail, and I am accustomed to hearing that, “Well, the Christmas season is a bit short this year, so that could be a problem.” But I actually caught him this time saying, “Gee, it’s so long this time that people seem to be losing interest.” [Laughter] On balance, I think the fundamentals for consumption are still reasonably good. Importantly, although they may be somewhat lagging, the payroll numbers are still consistent with decent growth in wage income, and the unemployment rate remains low. Elsewhere, foreign growth remains good, which along with the lower dollar should support continued growth in exports. We have seen some softening in capital spending as well, but the usual indicators still point to moderate gains in investment. These developments seem reasonably consistent with what I heard from business contacts. Most of them think that growth is slowing, and they are more cautious, but I would summarize their views as guarded and not alarmist. Furthermore, many say that their improved inventory control methods are preventing an inventory cycle from exacerbating the current situation, and they bring this up without my prompting. So to me their comments do not yet suggest a sharp curtailment in real economic activity. Of course, the financial markets continue to weigh negatively on the outlook. In my view, the biggest concerns are the large markdowns on structured securities and the volume of assets that may be returning to banks’ balance sheets. These effects appear to be larger than the banks had planned for as of October and could have a significant impact on lending capacity. This is an important downside risk to the real economy, as the Greenbook highlights in many places. That said, when I talk with my business contacts, there continues to be a disconnect between the credit conditions they report facing and the turbulence we see in money and credit markets. Outside of lending for residential and nonresidential construction, my CEO contacts at nonfinancial firms do not report much change in credit costs or availability. We have heard this from a number of sources. For example, two of the larger banks in our District said they have not changed terms to borrowers, and they expressed relatively sanguine views of lending conditions overall. For the time being, some lenders report offsetting a portion of their higher funding costs by taking a hit on their interest margins. Credit conditions for construction-related industries are another matter. A major shopping center developer who has been one of the largest issuers of commercial mortgage- backed securities indicated that this market has dried up completely. However, the developer has been able to obtain financing from other traditional sources, such as life insurance companies. He is paying similar interest rates, he says, but the terms include lower loan-to-value ratios. So there is some credit effect, but he still has access for the moment. That is a bit like what President Lacker was suggesting. He said the switch is not a big deal for him currently, but if it continues for too long—say, for more than six months or so—it would then weigh more heavily on his business activity. The evolution of such developments will obviously be an important thing to watch over the next few meetings. I would just note that I don’t often look at the Duke University survey of CFOs. But as I looked at it—and I don’t have a great deal of experience— it did seem to indicate that they had higher spending plans on average from their September survey for capital expenditures and technology spending. It wasn’t a great bit, but given all the negative headlines associated with the credit conditions—which are unweighted, whereas these spending plans are weighted—that was a bit of a surprise. Putting all of this together, we have marked down our current quarter and 2008 real GDP forecasts 0.4 percentage point, which is pretty significant. We now have growth next year of 2¼ percent. We expect growth to improve to our assessment of potential thereafter, namely about 2½ percent. This forecast assumes two policy easings, similar to but sooner than the Greenbook, and it is shaded toward the “stronger domestic demand” alternative scenario, which has less financial restraint on PCE and business fixed investment than in the Greenbook baseline. Turning to inflation, our forecast is for PCE inflation to settle in at 1.8 percent. This continued favorable projection for inflation is important for my policy views now. We think resource utilization likely will be about neutral for inflation over this forecast period. Our GDP projection does not result in appreciable resource slack over the forecast period. Even under the weaker Greenbook scenario, the GDP gap remains less than ½ percentage point. But there are upside risks. The most recent data on core prices have been a bit higher. The lower dollar could put pressure on prices, and my business contacts remain concerned about the cost of energy and other commodities. Finally, at least by the Board staff calculations, five-year forward TIPS inflation compensation has moved up to the range that it was in during the spring of 2006, a period when we were more concerned about the inflation outlook. I wouldn’t put too much weight on this particular inflation expectation development at the moment, but it may be looming ahead. So I continue to see upside risk to inflation, which if realized would complicate our policy reaction to developments on the growth and employment side of the ledger. Thank you, Mr. Chairman." FOMC20070321meeting--173 171,MR. WARSH.," Thank you, Mr. Chairman. I also generally share the views of alternative B and favor maintaining the federal funds rate today. I thought what I’d do is just highlight a couple of things. First, I think the statement needs to be reflective of the real economy rather than financial markets, as we discussed yesterday. So let me spend a moment on the reference to “still-favorable financial conditions” in alternative B. I think the financial conditions are still favorable, and so that’s an honest depiction of events, as is the rest of the statement after the reference to coming quarters. I think the question really is, If we enter the debate over describing the financial conditions, how do we get out of it? So when we meet next, I’m wondering how we’ll then describe the financial conditions. Or if we stop any reference thereto, what is that saying? That is, I think these markets are adjusting in a very orderly way. I don’t feel now, as I feared a few weeks ago, that we would have to say and do things to ensure that adjustment occurs. If we don’t refer to these financial conditions and we continue to suggest that we think the economy will expand at a moderate pace over the coming quarters, that in itself shows that we have some degree of comfort that the financial market tumult hasn’t really changed our central tendency. So though I’m comfortable with the honest depiction of all of alternative B, I worry a bit about what our exit strategy is. I can’t come up with a better way in which to refer to financial conditions without inviting that discussion, and so I’m left with puzzlement about an exit strategy on that question. The most important thing that we’re accomplishing in alternative B is suggesting that we aren’t going to come to the rescue of market tumult, that market discipline is working, that we don’t want complacency in the markets, and that our job is not to make sure that people make money in those markets. Our job, as many of you have said, is to keep the economy on an even keel. So with that, I favor alternative B, but I will remain a little uncomfortable until someone can tell how we answer the question about what we do next regarding the reference to still-favorable financial conditions." FOMC20080430meeting--184 182,MS. YELLEN.," Thank you, Mr. Chairman. I favor alternative B with the wording that has been proposed. But I do appreciate that there is a case for alternative C as well, and I understand and appreciate the arguments that have been made in favor of it. On the pure economic merits, I definitely support a 25 basis point cut. As I noted in my comments on the economic situation, it appears that the economy has stalled and may have fallen into a recession. I share the same concerns as Governor Kohn and President Stern. My forecast is close to the Greenbook. I think a further easing in financial conditions is needed to counter the credit crunch, and I believe that a cut in the federal funds rate will be efficacious in easing financial conditions. Although the real federal funds rate is accommodative by any usual measure of it, I completely agree with Governor Kohn's discussion of this topic. This is a situation in which spreads have increased so much and credit availability has diminished so much that looking at the real federal funds rate is just a very misleading way of assessing the overall tightness of financial conditions. I consider them, on balance, to be notably tighter than they were in the beginning of August. I don't agree that further cuts in the federal funds rate will be ineffective in helping us achieve our employment goal or counterproductive to the attainment of price stability over the medium term. Given that a 25 basis point cut is what the markets are now anticipating--it is built in--I would not expect this action, coupled with the language in alternative B, to touch off further declines in the dollar or to exacerbate inflationary expectations. That said, I did see arguments in favor of alternative C as well. I can see some advantage in doing a little less today than markets are expecting as long as we reaffirm that we do retain the flexibility to respond quickly to further negative news with additional cuts. A case that could be made for pausing is that we will soon get information relating to GDP in the second quarter and get a better read on just how serious the downturn is. With respect to market and inflationary psychology, I also can see a case for doing less than markets expect. It is true that some measures of inflation expectations have edged up a bit, and I would agree with President Fisher that perhaps a pause would counter any impression that we have become more tolerant of inflation in the long run. But I don't think we have become more tolerant of inflation in the long run, and I did see today's reading on the employment cost index as further confirmation that at this point nothing is built into labor markets that suggests that we are developing a wage�price spiral of the type that was of such concern and really propelling the problems in the 1970s. On the other hand, I agree with President Plosser, too. Wages aren't a leading indicator. We have to watch inflationary expectations. So I don't think that is definitive. Nevertheless, I do find it quite reassuring that nothing is going on there at this point. I think doing nothing today might mitigate the risk of a flight from dollar assets, which could exacerbate financial turmoil. So there are arguments in favor of alternative C, and I recognize them. But, on balance, I believe that the stronger case is for B. " FOMC20070816confcall--60 58,CHAIRMAN BERNANKE.," All right. That’s true. I’m sorry. So I’ll read it. I hope you can get it from there. “Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.” It still gives us our base case—“Recent data suggest that the economy has continued to expand at a moderate pace”—and we say that we’re monitoring the situation and are prepared to act as needed to mitigate the effects. Basically what we are doing here is acknowledging increased risks. It’s a little ambiguous as to what the balance of risks is. Clearly, it raises the probability of action—no question. I certainly don’t think, particularly if financial markets are somewhat calmer, that it commits us to action, but it does increase the probability. It is possible that, given what the markets are discounting for future actions, they’ll be disappointed with this statement, and we might even get a de facto tightening. But I think we just need to state an accurate expression of our views at this time." FOMC20080625meeting--94 92,MR. WARSH.," Thank you, Mr. Chairman. At this point everything has been said, but everybody hasn't said it. So let me try. [Laughter] Let me make three summary points, and then I will talk about three issues that I think are harder. First, on the economy, through late May, as the Greenbook suggests, the real economy proved more resilient and more dynamic than the consensus had anticipated. Consumer spending was moderate but positive, and the labor markets were soft, but neither was necessarily indicative of a recession through late May. Business fixed investment and corporate profits ex financials look all right. Productivity growth looks, frankly, impressive, and corporations, unlike consumers, still appear okay through the month of June--but I'm going to return to June in just a short while. In sum, my assessment of the economy reasonably approximates the average GDP from the Greenbook for 2008, but I remain considerably more cautious on the catalyst for return-to-trend growth in the forecast period of 2009 and beyond. I suspect that this is a long, slow climb with the credit channels needing to be rebuilt and that the process is still in its very early stages. Second, let me talk about the financial markets. Financial markets continue to show tenuous but real improvements in market functioning--which, as Bill Dudley suggested, is remarkable given the weakness among financial institutions themselves. Leveraged loans and high-yield markets continue to trend toward improved market functioning. Credit spreads are well off their March highs. Credit markets, in particular, are holding up well, despite the broad weakness across equities. Third, let me turn to inflation risks. Inflation risks, in my view, continue to predominate as the greater risk to the economy. There is more evidence of a global secular reversal of inflation trends, making the jobs of central bankers worldwide considerably more difficult. I remain worried about energy and food pass-through and the effect of a weakening dollar if our policy rates and those of our major trading partners are perceived to diverge. I would expect import prices, core inflation, and expectations to move up in the coming months even more than in the Greenbook, likely causing a policy response by our foreign peers. Commodity prices, again, with the exception of metals, have been moving up while global demand is falling, and markets have come to see this rise of some, if not most, commodities as essentially permanent. So at the end of the day, we have to be concerned about this period of above-acceptable inflation. It's crucial that broader prices do not start to rise at still-faster rates, and that could well happen if those making decisions about prices and pay expect higher inflation in the future. Anecdotes are not comforting, particularly on the price front. As a result, I think the trajectory of inflation is less favorable than in the Greenbook, thereby necessitating a policy response more significant than the Greenbook would suggest. Let me turn to three even harder issues. One is consumer spending. We're not done with the second quarter, and my sense of what's happened in the first three weeks of June is pretty miserable. I hate to extrapolate based on three weeks of data to the trajectory of the economy. But from a discussion with contacts from three credit card companies that constitute a little more than half of the credit card spend, I would say that the views from these guys were shocking in how bad things looked in the past three to four weeks, particularly in comparison to reasonably positive news from the previous two months. It is suggestive that June will be much weaker than May, and if I add that to the figures on autos that are coming out of the Detroit Three, those are a couple of anecdotes that make me a little hesitant to declare with an exclamation mark what an enviable second quarter we've had. I also look at equity market prices sometimes as maybe telling us something. I would say that consumer companies and retailers over the last three weeks have gotten killed. So I'm a little hesitant to suggest that the second quarter is going to be strong. Delinquencies and charge-offs have also moved meaningfully to the downside in the last three or four weeks among these credit card companies, and this weakness appears to be much more focused on the coasts than it is in the center of the country. I heard that from three of three. My own view may be influenced by my take on the fiscal stimulus--it sure doesn't appear to be helping very much. The second issue that I continue to struggle with is financial institutions. Financial institution equity prices showed significant underperformance, and some people say that is the Federal Reserve's fault. We're talking up our concerns about inflation. We're changing the Treasury curve going forward. I think that is a total red herring. The reason that financials are getting killed is an equity story. They have business models that are having a hard time delivering profits in this environment. They have had to show a very tough quarterly set of losses. I think the problems on financials have to do with financials and not with the Fed, though there is a disturbing amount of chatter in the markets that somehow we're the cause of that. I am comforted, again as Bill Dudley reminded us, that the broader market functioning has been able to withstand this dramatic financial institution weakness. Whether at some point that will give out I don't know, but I'd say that's extremely encouraging. In addition, we have to recognize that massive amounts of new capital are going to be needed for financial institutions of all sizes. Given the weak performance of virtually every financial investment from November till now, I think it is very easy to see a supply�demand problem. It is very easy to see that, with the number of banks that come to these markets, some of them at some point might not be able to find capital even at dramatically lower prices than their expectations. It is prudent for us at the Fed to think about alternative sources of more-patient institutional funding during this period. The third issue for discussion is credit availability, especially for small businesses. This strikes me as being key to the labor market situation. Credit availability for small businesses has held up better than I would have expected four or five months ago, but pockets of weakness remain, particularly among the regional banks, which are a source of concern. I guess I've become convinced that credit lines have not been tapped out. There was a theory, one that I even had some sympathy toward, that increases in C&I lending in the last few quarters were involuntary, reflecting existing credit lines that were called upon. That strikes me as being somewhat overstated. According to anecdotes and our own survey of the terms of business lending, it does suggest that capital is still available for these small businesses to provide some strength to the economy; but again, continued weakness among the regionals could call that into question. Let me turn finally, Mr. Chairman, to the projections. I have some sympathy for the view that Vice Chairman Geithner put forth. It strikes me that at this time the markets will see the benefits of changing our communication strategy as, yet again, pretty small. The costs are harder for me to be certain about. So if anyone is proposing to do this during the next six months, I would have real hesitancy about introducing this variable into our communication strategy amid our assessment of all the other challenges that we have. So I favor having a trial run come October, but I think we should revisit where we stand on the inflation front, the financial institution front, and the growth front before adding this to the mix. To the extent that we find the appropriate time to go down this path, I would favor option 3. Thank you, Mr. Chairman. " FinancialCrisisReport--107 If salespeople don’t understand Option ARMs, they won’t sell them. Many felt that more training would be needed to better educate salespeople about this type of loan, and to change the mindset of current Loan Consultants. Some felt there were many within Washington Mutual who simply felt these loans were ‘bad’ for customers, probably from a lack of understanding the product and how it could benefit customers. ... It is critical that salespeople fully understand a customer’s financial situation and motivation for the loan. By taking into account these factors, they can recommend the loan that will best fit their customers’ needs. Given today’s low interest rate environment, it can be challenging to get salespeople to take the time to do this. Currently it is easier to give customers what they ask for (a 30 year fixed loan) than to sell them an Option ARM . They can take 20 minutes and sell a 30 fixed-rate loan, or spend an hour trying to sell an Option ARM. Commission caps make it unappealing for Mortgage Brokers to sell Washington Mutual Option ARMs . Most would not sell loans to customers with prepayment penalties, and given the low commission rate for selling them without the prepayment penalty, many simply go to another company or product where they can make more money. Slow ARM processing times (up to 90 days) can cause Mortgage Brokers to take business elsewhere . … Improving collateral would help salespeople better explain Option ARMs to customers and take away some of the mystery . … They also would like improved brochures which talk to the customer in simple, easy to understand terms about features and benefits. They liked the current sample statements they are provided.” 366 The second focus group with existing Option ARM customers showed they were also unenthusiastic about the product. The focus group report stated: “In general, people do not seem to have a good understanding of their mortgage and its terms. What understanding they do have is framed by the concept of a 30-year fixed mortgage. Option ARMs are very complicated and need to be explained in simple, easy 366 8/14/2003 “Option ARM Focus Groups – Phase I, WaMu Loan Consultants and Mortgage Brokers,” WaMu research report, at 2, Hearing Exhibit 4/13-36 [emphasis in original]. to understand terms, prospective borrowers need to be educated about the loan – this is not a product that sells itself.” 367 FOMC20070628meeting--177 175,MS. MINEHAN.," Thank you, Mr. Chairman. I, too, am in favor of keeping policy where it is. As I stated yesterday, I see the risks around growth as better balanced than they were, even given the potential for the housing problems to be deeper and longer-lasting than we might have expected earlier in the year. I remain concerned about the risks that inflation will not continue to moderate, but I am not wed, as I have said many times, to a particular low number. I would be as happy at 2 as at 1½ and perhaps even happier given that levels that start with 1 seem to have downside risks—or at least they did the last time we were there. I am concerned, however, about the pressures on the economy, whether you think of them in terms of headline inflation or in terms of the components of headline, particularly energy costs, tight labor markets, and a growing world. I think, although we may not want to put it in the statement, that Richard is right—our economy is subject to pressures from the rest of the world at this point and, related to that, the falling dollar. A lot of things could take inflation from its current moderate level and push it back up, and that I would be very concerned about. It is true that financial conditions have tightened slightly, so markets are starting to do a little work for us. But I believe that we need to continue with policy in a slightly restrictive stance to provide some insurance that the inflation pressures in the economy stay moderate. Staying with current policy is a good balance between the prospects we see for moderate growth and the prospects we also have recognized around the table for the potential for inflation pressures to get worse. I support alternative B’s language. I want to say two things. First, the more substantive concern—I think that Governor Kohn’s thoughts about inflation pressures are slightly better than the current language. I was attracted to the “transitory” language that I think President Moskow raised first, and we fiddled around with it a bit in Boston, but I have been convinced that “convincingly demonstrated” and “transitory” are equivalent. [Laughter] So I don’t want to battle about that at this table. The statement in section 3 is headed in the right direction, and I would be in favor of its current form or the form that Governor Kohn suggested. Second, I may be the only one sensitive to this, but in section 2 we have two sentences that start with exactly the same words. I never wrote that way when I was in school. [Laughter] There is an easy way to make that sentence a little better from an English composition point of view. But, again, that is tricky to argue about at the table, so I guess I am fine." CHRG-111shrg51395--96 Mr. Pickel," Yes, I think as far as the products themselves, if you look, for instance, at the credit default swap market, there is information that has been published by the Depository Trust and Clearing Corporation through their trade information warehouse, which encompasses 80 to 90 percent of credit default swaps engaged in around the world. And the information there is that virtually all the trades in that warehouse, essentially all, 100 percent, are done involving at least one dealer party who is, in fact, a regulated institution, and actually 86 percent of them are between two dealer institutions. So you have got that structure of the institutional regulation there, of the oversight of those individual firms looking at the activities of those firms. And I think the Committee, again, heard testimony from the OTS last week admitting some shortcomings in their enforcement and in their execution of their authority, but perhaps we should look at making sure that they have got the ability to understand and get more detail on the products that those individual entities are---- Senator Warner. Just a quick question, Mr. Pickel. But those 86 percent of institutions that are involved in using these products, are you saying the market knows all the terms and conditions and that we have got a transparent market there? " FOMC20081007confcall--3 1,MR. DUDLEY.," Yes. Thank you, Mr. Chairman. Despite our massive escalation on the liquidity provision front and passage of legislation granting the Treasury authority to set up a $700 billion troubled asset relief program, or TARP, market conditions continue to deteriorate. This is occurring in three broad respects. First, market participants continue to pull back in their willingness to engage with one another. This pullback is evident in elevated interbank lending rates and elevated foreign exchange swap bases and market liquidity more generally. The one-month and three-month LIBOR�OIS spreads have widened to 271 and 296 basis points, respectively. That is up more than 175 basis points in the past three weeks since the September 16 FOMC meeting. The all-in cost of dollar funding via the foreign exchange swap market, although bouncing around day to day, has actually been even higher than LIBOR, often by 100 basis points or more. In addition to the interbank market, the commercial paper market has come under stress. The breaking of the buck by the Reserve Fund led to a wholesale flight out of prime institutional money market funds. This forced the liquidation of assets, which has led to impairment of the commercial paper market. Term commercial paper rates are elevated, and the average tenor of commercial paper has shortened considerably. Second, financial conditions continue to tighten, and in recent weeks, the tightening has been substantial. Equity prices have plunged both in the United States and abroad. Corporate bond yields, especially for non-investment-grade debt, have increased substantially. Short- and long-term tax-exempt rates have climbed, and credit availability has been even further impaired. On the equity market side, for example, the S&P 500 index has fallen about 18 percent since the September 16 FOMC meeting. Although there is considerable uncertainty about the appropriate metrics and weights to use in examining the evolution of financial conditions over time, most data are consistent with the judgment that conditions have tightened significantly since the onset of the crisis, despite the 325 basis point reduction in the federal funds rate target. Compared with the previous two monetary policy easing cycles, there have been four important divergences. First, corporate bond yields have climbed. In previous cycles, the widening credit spreads were more than offset by the decline in Treasury note and bond yields, causing corporate bond yields to fall. Second, credit availability has declined greatly in this cycle. In the two previous cycles, the proportion of banks tightening credit standards actually fell through the easing cycle. That stands in sharp contrast to what has been happening in this cycle. Third, housing price declines have been far larger than in previous cycles, in real and in nominal terms. Fourth, the dollar has weakened actually much less than in the previous two easing cycles. The third aspect of the market that I think warrants noting is that the U.S. financial sector in particular remains under pressure, especially with respect to share prices and banks' ability to obtain funding, especially term funding. Today was a particularly bad day for financial shares, with double-digit declines common for many banks. The only good news was that credit default swaps actually narrowed a bit, maybe helped by the introduction of our commercial paper backstop facility or the fact that we've escalated so massively in terms of the term auction facility and the foreign exchange swaps with our foreign central bank counterparts. On the inflation side of the ledger, pressures continue to abate. Since the last FOMC meeting, both industrial and agricultural commodity price indexes have fallen about 15 percent. At the same time, the dollar has strengthened. The fall in the commodity prices and the strength in the dollar are two factors that have contributed to a fall in breakeven measures of inflation on both the spot and the five-year, five-year-forward basis. For example, the Barclays measure of five-year, five-year-forward breakeven inflation has declined more than 60 basis points since the September FOMC meeting. Today it was around 1.5 percent. The interbank, money market, and capital market dysfunction, the tightening of financial conditions, and the apparent easing in inflation risks have caused investors to conclude that the FOMC is likely to lower its federal funds rate target in the near future. Late today, the November federal funds futures contract implied an effective rate for the coming month of about 1.4 percent. That's more than 50 basis points below the current target. Interestingly, the failure of the FOMC to ease today actually led to a rise in October and November federal funds futures contracts. Market participants presumably interpreted the introduction of the commercial paper funding facility as potentially a substitute for further monetary policy accommodation at this time. Obviously, this is an extremely fragile and dangerous environment. I am struck by the feeble market response to the substantial escalations implemented over the past ten days. These include expanding standing foreign exchange swap facilities' capacity to $620 billion from $290 billion; expanding the TAF auction cycles to $900 billion from $150 billion; and proposing a major backstop for the commercial paper market. With respect to the commercial paper market backstop facility, the market reaction today was generally positive, but market participants clearly want to know more in terms of the specifics, especially when the program will be up and operational. Of course, I'm happy to take any questions. " CHRG-109hhrg28024--130 Mr. Bernanke," Congressman, I would say in terms of capital investment, there is currently plenty of funding available. Corporations have retained a lot of these profits they have earned in recent years, and they have very liquid balance sheets. There have been actually relatively low rates of bank borrowing by corporations because they have sufficient internal funds to finance their investment spending. Moreover, the general credit conditions still appear to be quite positive. Spreads are low. That is, bankruptcy risk appears to be relatively low. My sense is that we will continue to see strong growth in capital investment in the U.S. economy, and that is going to be beneficial both in terms of generating demand in the short run, but also in terms of expanding our capacity to produce and our productivity in the longer term. " FOMC20081029meeting--6 4,MR. BASSETT.," 2 Thank you, Nathan. I will be referring to the exhibits labeled in red, ""Staff Presentation on Financial Developments."" The intermeeting period was characterized by persistent strains in financial markets and a sharp drop in asset prices. Although some markets have improved in recent days, the ongoing disruptions have generated intense pressures on financial institutions and have contributed to a significant further tightening of credit conditions for households and businesses. As Bill Dudley noted, spreads on credit default swaps (CDS) for financial institutions have been quite volatile. As shown by the top left panel of your first exhibit, median spreads for large bank holding companies (the black line) and regional commercial banks (the red line) declined substantially after the announcement of the Treasury's capital purchase program and the FDIC's temporary liquidity guarantee program on October 14; they ended the period almost 70 basis points lower, on balance. The median CDS spread for insurance companies (the blue line) increased substantially over the latter part of the intermeeting period amid concerns about the financial condition of these firms. Judging from the wide range of dealers' price quotes on CDS for the same firms (shown in the top right panel), liquidity and price discovery in the CDS market remain strained. The functioning of markets for corporate debt is also impaired. As shown by the blue line in the middle left panel, the staff's proxy for the bid-asked spread on highyield bonds spiked to more than 4 percent before partially reversing course over the past week. This spread is also unusually elevated for investment-grade bonds (the black line). As shown to the right, the average bid-asked spread on syndicated loans traded in the secondary market (the black line) jumped up over the intermeeting period. Secondary market prices for syndicated loans (the blue line) dropped to unprecedented levels, reportedly reflecting heavy sales by hedge funds that were forced to meet investor redemptions as well as the unwinding of some types of structured investments. Municipal finance, the subject of the bottom two panels, was significantly disrupted by dislocations in money market mutual funds in September and record 2 The materials used by Mr. Bassett are appended to this transcript (appendix 2). withdrawals from long-term municipal bond funds in early October. Markets for structured products, such as tender-option bonds, that issued short-term variable-rate debt backed by longer-term municipal bonds were particularly affected. Yields on those short-term instruments (shown by the black line in the bottom left panel) jumped for a time, and the sales of the underlying long-term bonds as the structures unwound boosted long-term municipal bond yields (the blue line). As shown to the right, issuance slowed substantially until mid-October, when a few states--notably California--placed a sizable amount of new debt, though they paid fairly elevated interest rates to do so. In recent days, however, liquidity conditions have shown signs of improvement, yields have decreased somewhat, and issuance has moved back up from the extremely slow pace seen in the second half of September and the first half of this month. Please turn to exhibit 2. As noted by Bill Dudley, prime money market funds suffered a wave of redemptions in mid-September, shown by the red bars in the top left panel. Although the flows diminished after the Federal Reserve and the Treasury announced steps to support money funds on September 19, prime funds lost about one-fifth of their assets, on net, over the intermeeting period. As a result, prime funds have dramatically reduced their holdings of commercial paper, generating significant disruptions in that market. As shown by the black line in the top right panel, unsecured financial commercial paper outstanding has declined sharply since midSeptember, and the ongoing contraction in ABCP (the blue line) has continued. In contrast, the amount of unsecured commercial paper placed by nonfinancial firms (the yellow line) was little changed, on net, over the period. As shown in the middle left panel, broad equity prices (the black line) dropped about 30 percent over the intermeeting period as the outlook for both economic growth and earnings dimmed, and implied volatility increased to record levels. As depicted by the red bars to the right, those developments were accompanied by record outflows of about $60 billion from equity mutual funds in September. Weekly data indicate that, over the first half of October, investors withdrew more than $100 billion from long-term mutual funds, including about $70 billion from equity funds, but outflows have slowed in recent days. As shown in line 1 in the bottom left panel, M2 expanded rapidly in September and early October as some firms and households shifted toward safer assets. Liquid deposits (line 2) increased significantly in September and stayed about flat in October. In contrast, retail money funds (line 3) were little changed in September but have grown briskly this month. The sizable increases in small time deposits in both months (line 4) were widespread, in contrast to the more concentrated gains seen over the summer in response to elevated yields at a few financial institutions. Currency (line 5) began increasing rapidly in recent weeks, apparently supported by higher demand from both foreign and domestic holders. As a result of the disruptions in short-term funding markets, a range of borrowers turned to banks for funding. The ""other loans"" category (the blue line in the bottom right panel) rose sharply beginning in mid-September as a result of both unplanned overdrafts and draws on existing credit lines by nonfinancial businesses, money market mutual fund complexes, foreign banks, nonbank financial institutions, and municipalities. C&I loans at banks (the black line) have also increased significantly in recent weeks, as a broad spectrum of nonfinancial firms tapped existing credit lines. According to the October Senior Loan Officer Opinion Survey, however, about 25 percent of the largest banks and 35 percent of other banks surveyed indicated that C&I loans not made under previous commitment accounted for some of the recent increase. Additional results from the survey are the subject of your next exhibit. Large net fractions of institutions reported having continued to tighten their lending standards and terms on all major loan categories over the previous three months, with some banks reporting that they had tightened lending policies considerably. As shown by the black line in the top left panel, about 80 percent of domestic respondents tightened their lending standards on C&I loans since July, and all but one of the 54 banks surveyed reported charging higher spreads over their cost of funds on such loans (the red line). As noted to the right, nearly all the banks that tightened standards or terms did so in response to a more uncertain or less favorable economic outlook and a reduced tolerance for risk. Almost 40 percent of domestic banks tightened in part because of concerns about their capital or liquidity position, somewhat more than had cited those pressures in July. As indicated in the middle left panel, a large fraction of domestic banks again reported tightening standards on commercial real estate loans over the past three months. Moving to loans to households, almost 70 percent of respondents tightened standards on residential mortgages to prime borrowers (the red line in the middle right panel). As shown by the blue line, nearly 90 percent of the institutions that originated nontraditional mortgages tightened standards on such loans. As shown by the short black line in the bottom left panel, about 75 percent of the respondents tightened lending standards on home equity lines of credit, and about 60 percent tightened standards on both credit cards (the blue line) and other consumer loans (the red line). As noted to the right, almost 25 percent of banks, on net, reported reducing the credit limits on existing credit card accounts of some prime customers over the past three months, and about 60 percent of banks reported cutting existing lines of some of their nonprime borrowers. Banks that had trimmed the limits on existing credit card accounts most often cited the more uncertain economic outlook as a very important reason followed, in turn, by a reduced tolerance for risk and deterioration in the credit quality of individual customers. Business finance is the subject of your next exhibit. The spread on BBB-rated bonds issued by nonfinancial corporations (the blue line in the top left panel) rose about 275 basis points over the intermeeting period, to more than 600 basis points, whereas that on bonds of financial firms (the black line) reached nearly 1,000 basis points before easing some in recent days. As spreads spiked and volatility increased, bond issuance by both nonfinancial and financial corporations (shown in the table to the right) dropped appreciably in the third quarter (row 3) relative to the pace seen in the first half of the year (row 2). As shown in the last row, there has been no highyield issuance by nonfinancial firms so far this month, and bond issuance by financial firms has come to a near halt. In commercial mortgage markets, secondary market spreads on AAA-rated commercial mortgage-backed securities (CMBS), shown in the middle left panel, continued to increase on net, and no new CMBS have been issued for several months. As noted to the right, using announced earnings for about 200 firms and analysts' estimates for the rest, the staff expects third-quarter S&P 500 earnings to come in about 10 percent below the level posted in the third quarter of last year. Losses at financial companies account for the drop. Bank holding companies reported further substantial write-downs on mortgage-related and other securities as well as higher loan-loss provisions necessitated by widespread deterioration in credit quality. In contrast, earnings of nonfinancial companies are projected to have risen about 12 percent from a year earlier, but increased profits of energy companies account for virtually all of those gains. As indicated in the bottom left panel, analysts have revised down significantly their expectations for earnings of nonfinancial firms (the red line) over the next year, likely in response to the worsening economic outlook. Expected earnings for financial firms (the black line) also have been cut further this month. A rough estimate of the equity premium (shown in the bottom right panel) stands at an extremely high level. The household sector is the subject of your last exhibit. As shown by the top left panel, interest rates on conforming residential mortgages have been volatile--partly in response to the renewed pressures on GSE debt noted by Bill Dudley--but ended the period only slightly higher at around 6 percent. The staff expects home prices (the black line to the right) to decline significantly further through the end of 2010 and mortgage debt (the red line) to be about flat over that period. Both paths have been marked down from the September forecast to reflect a weaker economic outlook and tighter credit conditions. Spreads on asset-backed securities backed by credit card loans (the black line in the middle left panel) and auto loans (the red line) have risen more than 150 basis points since mid-September, moving well above their spring peaks. The cumulative increase in spreads since midyear has hindered issuance of such securities, and the volume of new deals, shown to the right, dropped more than 50 percent in the third quarter. The latest data, available through October 17, suggest that very little issuance has occurred this month. As shown in the bottom left panel, consumer credit has decelerated recently. With lending conditions likely to remain tight and with spending on durables expected to be soft, the staff sees significant further weakness in consumer credit in coming quarters. Summing up, although there has been modest improvement in several financial markets recently, the worsening of the global financial crisis sharply increased pressures on financial firms and markets over the intermeeting period as a whole. Those pressures have led to further deleveraging, diminished liquidity, increased concerns among investors about the economic outlook, and a reduced tolerance for risk-taking. The resulting sharp fall in asset prices and the further tightening of credit conditions have had substantial adverse effects on nonfinancial businesses and households. That concludes my prepared remarks. " CHRG-111hhrg56766--74 Mr. Bernanke," Congresswoman, it is not the Federal funds rate, it was the discount rate, the rate at which we lend on a special overnight basis to banks, we cut that very low because of the financial crisis. We wanted to make sure that banks had access to lots of liquidity in case there was a run on the banks. Now that there is easy access to private markets, they do not need that kind of help any more, so we have just slightly reduced the subsidy we are giving to banks. It has nothing to do with the Federal funds rate or the overall stance of monetary policy. It has to do with normalizing our extraordinary support for the banks and the financial markets. We do not anticipate that action having any implications-- Ms. Waters. Let's be clear. The change that you have made, no matter how slight it is, at the discount rate, will increase the amount they have to pay for their loans, the banks; is that right? " fcic_final_report_full--5 Much attention over the past two years has been focused on the decisions by the federal government to provide massive financial assistance to stabilize the financial system and rescue large financial institutions that were deemed too systemically im- portant to fail. Those decisions—and the deep emotions surrounding them—will be debated long into the future. But our mission was to ask and answer this central ques- tion: how did it come to pass that in  our nation was forced to choose between two stark and painful alternatives —either risk the total collapse of our financial system and economy or inject trillions of taxpayer dollars into the financial system and an array of companies, as millions of Americans still lost their jobs, their savings, and their homes? In this report, we detail the events of the crisis. But a simple summary, as we see it, is useful at the outset. While the vulnerabilities that created the potential for cri- sis were years in the making, it was the collapse of the housing bubble—fueled by low interest rates, easy and available credit, scant regulation, and toxic mortgages— that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of . Trillions of dollars in risky mortgages had become embedded throughout the financial system, as mortgage-related securities were packaged, repackaged, and sold to investors around the world. When the bubble burst, hun- dreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them. This happened not just in the United States but around the world. The losses were magnified by derivatives such as synthetic securities. The crisis reached seismic proportions in September  with the failure of Lehman Brothers and the impending collapse of the insurance giant American Interna- tional Group (AIG). Panic fanned by a lack of transparency of the balance sheets of ma- jor financial institutions, coupled with a tangle of interconnections among institutions perceived to be “too big to fail,” caused the credit markets to seize up. Trading ground to a halt. The stock market plummeted. The economy plunged into a deep recession. The financial system we examined bears little resemblance to that of our parents’ generation. The changes in the past three decades alone have been remarkable. The financial markets have become increasingly globalized. Technology has transformed the efficiency, speed, and complexity of financial instruments and transactions. There is broader access to and lower costs of financing than ever before. And the financial sector itself has become a much more dominant force in our economy. CHRG-110hhrg46594--409 Mr. Sachs," First, before getting to the specifics of section 136, we should not ease the conditions. We should see this as an opportunity to enforce the conditions. I actually am more optimistic than the three CEOs that we heard that they could be accelerated even more because when you consider the Chevy Volt promises to be a leapfrog technology, in fact because we will go from hybrid to plug-in hybrid, we are on the verge in my opinion of getting back to U.S. technological leadership. GM also has invested more than $1 billion in hydrogen fuel cells. And Chrysler, I think very impressively, is looking at extended range electric vehicles. Don't ease the conditions, that is for sure. My only question would be, you know, section 136 could be a bridge. We could see the money as a bridge to the Chevy Volt, to the EREV, and so forth. So it doesn't seem to me to be contradictory in that way. I think the approach this committee has taken is the right one though. The TARP really fits, in my opinion. This is a financial crisis. The money is there, adjust it in a modest way and get a very pragmatic result. Section 136, if it had to be a fallback position, seems to me to be a viable one but not by easing the conditions at all. Indeed, by seeing the money is precisely to get us to that Chevy Volt. It is to get us to the EREV. Please don't ease the conditions. That would send every wrong message for the country. " CHRG-111shrg50814--8 Mr. Bernanke," Thank you. Chairman Dodd, Senator Shelby, and Members of the Committee, I appreciate the opportunity to discuss monetary policy and the economic situation and to present the Federal Reserve's monetary policy report to the Congress. As you are aware, the U.S. economy is undergoing a severe contraction. Employment has fallen steeply since last autumn, and the unemployment rate has moved up to 7.6 percent. The deteriorating job market, considerable losses of equity and housing wealth, and tight lending conditions have weighed down on consumer sentiment and spending. In addition, businesses have cut back capital outlays in response to the softening outlook for sales, as well as the difficulty of obtaining credit. In contrast to the first half of last year, when robust foreign demand for U.S. goods and services provided some offset to weakness in domestic spending, exports slumped in the second half as our major trading partners fell into recession and some measures of global growth turned negative the first time in more than 25 years. In all, U.S. real gross domestic product declined slightly in the third quarter of 2008, and that decline steepened considerably in the fourth quarter. The sharp contraction in economic activity appears to have continued into the first quarter of 2009. The substantial declines in the prices of energy and other commodities last year and the growing margin of economic slack have contributed to a substantial lessening of inflation pressures. Indeed, overall consumer price inflation measured on a 12-month basis was close to zero last month. Core inflation, which excludes the direct effects of food and energy prices, also has declined significantly. The principal cause of the economic slowdown was the collapse of the global credit boom and the ensuing financial crisis, which has affected asset values, credit conditions, and consumer and business confidence around the world. The immediate trigger of the crisis was the end of the housing booms in the United States and other countries and the associated problems in mortgage markets, notably the collapse of the U.S. subprime mortgage market. Conditions in housing and mortgage markets have proved a serious drag on the broader economy, both directly through their impact on residential construction and related industries and on household wealth, and indirectly through the effects of rising mortgage delinquencies on the health of financial institutions. Recent data show that residential construction and sales continue to be very weak, house prices continue to fall, and foreclosure starts remain at very high levels. The financial crisis intensified significantly in September and October. In September, the Treasury and the Federal Housing Finance Agency placed the Government-sponsored enterprises Fannie Mae and Freddie Mac into conservatorship, and Lehman Brothers Holdings filed for bankruptcy. In the following weeks, several other large financial institutions failed, came to the brink of failure, or were acquired by competitors under distressed circumstances. Losses at a prominent money market mutual fund prompted investors, who had traditionally considered money market mutual funds to be virtually risk free, to withdraw large amounts from such funds. The resulting outflows threatened the stability of short-term funding markets, particularly the commercial paper market, upon which corporations rely heavily for their short-term borrowing needs. Concerns about potential losses also undermined confidence in wholesale bank funding markets, leading to further increases in bank borrowing costs and a tightening of credit availability from banks. Recognizing the critical importance of the provision of credit to businesses and households from financial institutions, the Congress passed the Emergency Economic Stabilization Act last fall. Under the authority granted by this act, the Treasury purchased preferred shares in a broad range of depository institutions to shore up their capital basis. During this period, the FDIC introduced its Temporary Liquidity Guarantee Program, which expanded its guarantees of bank liabilities to include selected senior unsecured obligations and all non-interest-bearing transactions deposits. The Treasury, in concert with the Federal Reserve and the FDIC, provided packages of loans and guarantees to ensure the continued stability of Citigroup and Bank of America, two of the world's largest banks. Over this period, governments in many foreign countries also announced plans to stabilize their financial institutions, including through large-scale capital injections, expansions of deposit insurance, and guarantees of some forms of bank debt. Faced with the significant deterioration of financial market conditions and the substantial worsening of the economic outlook, the Federal Open Market Committee continued to ease monetary policy aggressively in the final months of 2008, including a rate cut coordinated with five other major central banks. In December, the FOMC brought its target for the Federal funds rate to a historically low range of zero to one-quarter percent, where it remains today. The FOMC anticipates that economic conditions are likely to warrant exceptionally low levels of the Federal funds rate for some time. With the Federal funds rate near its floor, the Federal Reserve has taken additional steps to ease credit conditions. To support housing markets and economic activity more broadly and to improve mortgage market functioning, the Federal Reserve has begun to purchase large amounts of agency debt and agency mortgage-backed securities. Since the announcement of this program last November, the conforming fixed mortgage rate has fallen nearly 1 percentage point. The Federal Reserve also established new lending facilities and expanded existing facilities to enhance the flow of credit to businesses and households. In response to the heightened stress in bank funding markets, we increased the size of the Term Auction Facility to help ensure that banks could obtain the funds they need to provide credit to their customers, and we expanded our network of swap lines with foreign central banks to ease conditions in interconnected dollar funding markets at home and abroad. We also established new lending facilities to support the functioning of the commercial paper market and to ease pressures on money market mutual funds. In an effort to restart securitization markets to support the extension of credit to consumers and small businesses, we joined with the Treasury to announce the Term Asset-backed Securities Loan Facility, or TALF. The TALF is expected to begin extending loans soon. The measures taken by the Federal Reserve, other U.S. Government entities, and foreign governments since September have helped to restore a degree of stability to some financial markets. In particular, strains in short-term funding markets have eased notably since last fall, and London Interbank Offered Rates, or LIBOR, upon which borrowing costs for many households and businesses are based, have decreased sharply. Conditions in the commercial paper market also have improved, even for lower-rated borrowers, and the sharp outflows from money market mutual funds seen in September have been replaced by modest inflows. Corporate risk spreads have declined somewhat from extraordinarily high levels, although these spreads remain elevated by historical standards. Likely spurred by the improvements in pricing and liquidity, issuance of investment-grade corporate bonds has been strong, and speculative-grade issuance, which was near zero in the fourth quarter, has picked up somewhat. As I mentioned earlier, conforming fixed mortgage rates for households have declined. Nevertheless, despite these favorable developments, significant stresses persist in many markets. Notably, most securitization markets remain shut other than that for conforming mortgages, and some financial institutions remain under pressure. In light of ongoing concerns over the health of financial institutions, the Secretary of the Treasury recently announced a plan for further actions. This plan includes four principal elements. First, a new Capital Assistance Program will be established to ensure that banks have adequate buffers of high-quality capital based on results of comprehensive stress tests to be conducted by the financial regulators, including the Federal Reserve. Second is a Private-Public Investment Fund in which private capital will be leveraged with public funds to purchase legacy assets from financial institutions. Third, the Federal Reserve, using capital provided by the Treasury, plans to expand the size and scope of the TALF to include securities backed by commercial real estate loans and potentially other types of asset-based securities as well. And, fourth, the plan includes a range of measures to help prevent unnecessary foreclosures. Together, over time, these initiatives should further stabilize our financial institutions and markets, improving confidence and helping to restore the flow of credit needed to promote economic recovery. The Federal Reserve is committed to keeping the Congress and the public informed about its lending programs and balance sheet. For example, we continue to add to the information shown in the Fed's H41 statistical release, which provides weekly detail on the balance sheet and the amounts outstanding for each of the Federal Reserve's lending facilities. Extensive additional information about each of the Federal Reserve's lending programs is available online. The Fed also provides bimonthly reports to the Congress on each of its programs that rely on the Section 13(3) authorities. Generally, our disclosure policies reflect the current best practices of major central banks around the world. In addition, the Federal Reserve's internal controls and management practices are closely monitored by an independent Inspector General, outside private sector auditors, and internal management and operations divisions, and through periodic reviews by the Government Accountability Office. All that said, we recognize that recent developments have led to a substantial increase in the public's interest in the Fed's programs and balance sheet. For this reason, we at the Fed have begun a thorough review of our disclosure policies and the effectiveness of our communication. Today, I would like to highlight two initiatives. First, to improve public access to information concerning Fed policies and programs, we recently unveiled a new section of our Web site that brings together in a systematic and comprehensive way the full range of information that the Federal Reserve already makes available, supplemented by explanations, discussions, and analyses. We will use that Web site as one means of keeping the public and the Congress fully informed about Fed programs. Second, at my request, Board Vice Chairman Donald Kohn is leading a committee that will review our current publications and disclosure policies relating to the Fed's balance sheet and lending policies. The presumption of the committee will be that the public has the right to know and that the non-disclosure of information must be affirmatively justified by clearly articulated criteria for confidentiality based on factors such as reasonable claims to privacy, the confidentiality of supervisory information, and the need to ensure the effectiveness of policy. In their economic projections for the January FOMC meeting, monetary policymakers substantially marked down their forecasts for real GDP this year relative to the forecast they had prepared in October. The central tendency of their most recent projections for real GDP implies a decline of one-and-one-half percent to one-and-one-quarter percent over the four quarters of 2009. These projections reflect an expected significant contraction in the first half of this year, combined with an anticipated gradual resumption of growth in the second half. The central tendency for the unemployment rate in the fourth quarter of 2009 was marked up to a range of eight-and-a-half percent to eight-and-three-quarters percent. Federal Reserve policymakers continue to expect moderate expansion next year, with a central tendency of two-and-a-half percent to three-and-a-quarter percent growth in real GDP and a decline in the unemployment rate by the end of 2010 to a central tendency of 8 percent to eight-and-a-quarter percent. FOMC participants marked down their projections for overall inflation in 2009 to a central tendency of one-quarter percent to 1 percent, reflecting expected weakness in commodity prices and the disinflationary effects of significant economic slack. The projections for core inflation also were marked down to a central tendency bracketing 1 percent. Both overall and core inflation are expected to remain low over the next 2 years. This outlook for economic activity is subject to considerable uncertainty, and I believe that, overall, the downside risks probably outweigh those on the upside. One risk arises from the global nature of the slowdown, which could adversely affect U.S. exports and financial conditions to an even greater degree than currently expected. Another risk arises from the destructive power of the so-called adverse feedback loop in which weakening economic and financial conditions become mutually reinforcing. To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets. If actions taken by the administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability, and only if that is the case, in my view, there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery. If financial conditions improve, the economy will be increasingly supported by fiscal and monetary stimulus, the salutary effects of the steep decline in energy prices since last summer, and the better alignment of business inventories and final sales, as well as the increased availability of credit. To further increase the information conveyed by the quarterly projections, FOMC participants agreed in January to begin publishing their estimates of the values to which they expect key economic variables to converge over the longer run, say at a horizon of 5 to 6 years, under the assumption of appropriate monetary policy and in the absence of new shocks to the economy. The central tendency for the participants' estimates of a longer run growth rate of real GDP is two-and-a-half percent to two-and-three-quarters percent. As to the longer rate of unemployment, it is four-and-three-quarter percent to 5 percent. And as to the longer rate of inflation, it is one-and-three-quarter percent to 2 percent, with the majority of participants looking for 2 percent inflation in the long run. These values are all notably different from the central tendencies of the projections for 2010 and 2011, reflecting the view of policymakers that a full recovery of the economy from the current recession is likely to take more than 2 or 3 years. The longer-run projections for output growth and unemployment may be interpreted as the Committee's estimates of the rate of growth of output and the unemployment rate that are sustainable in the long run in the United States, taking into account important influences such as the trend in growth rates of productivity in the labor force, improvements in worker education and skills, the efficiency of the labor market at matching workers and jobs, government policies affecting technological development, or the labor market and other factors. The longer-run projections of inflation may be interpreted, in turn, as the rate of inflation that FOMC participants see as most consistent with the dual mandate given to it by the Congress, that is the rate of inflation that promotes maximum sustainable employment while also delivering reasonable price stability. This further extension of the quarterly projection should provide the public a clearer picture of the FOMC's policy strategy for promoting maximum employment and price stability over time. Also, increased clarity about the FOMC's views regarding longer-run inflation should help to better stabilize the public's inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low. At the time of our last monetary policy report, the Federal Reserve was confronted with both high inflation and rising unemployment. Since that report, however, inflation pressures have receded dramatically while the rise in the unemployment rate has accelerated and financial conditions have deteriorated. In light of these developments, the Federal Reserve is committed to using all available tools to stimulate economic activity and to improve financial market functioning. Toward that end, we have reduced the target for the Federal Funds Rate close to zero and we have established a number of programs to increase the flow of credit to key sectors of the economy. We believe that these actions, combined with the broad range of other fiscal and financial measures being put into place, will contribute to a gradual resumption of economic growth and improvement in labor market conditions in a context of low inflation. We will continue to work closely with the Congress and the administration to explore means of fulfilling our mission of promoting maximum employment and price stability. Thank you, Mr. Chairman. " CHRG-111hhrg48674--128 Mr. Meeks," Thank you, Mr. Chairman. Mr. Chairman, I have really two separate questions that I want to ask. The first goes toward local municipalities. I actually had a big question with my comptroller in the City of New York, and we started talking about munibonds that the City of New York tries to, has to sell. It is important for them to sell the variable rate debt. One of the things that they had indicated to me that was tremendously important was that, under the numerous programs that were designed for banks and security firms to use as commercial paper to credit cardholders, that they can continue to get access to credit. But the one group of borrowers that I am told left out of all this help is State and local governments. I am told the conditions in the municipal bond market are better than they were 2 months ago but by no means back to normal, and many State and local governments want to borrow to finance new construction projects. We have a lot of new construction projects but cannot access the capital market at reasonable terms. So the question is, do you think to help these local governments and municipalities, would you support initiatives designed to make financing more readily available to States and localities, such as providing standby liquidity facilities for variable rate municipal bonds? " FOMC20060808meeting--181 179,MR. PLOSSER.," Thank you, Mr. Chairman. The goals are pretty clearly stated, and I have no real problems with them. I agree that communication and transparency are really a key part of maintaining and enhancing our own credibility. I also understand, as I listen to people around the table and other conversations, that some of these issues have no easy or clear answers to them, and I should note in advance that my own views are evolving as I think about and understand the nuances of the issues. I agree with President Yellen. I’d like to applaud the Committee because in the past ten years there have really been great strides in both transparency and communication. Part of the challenge, it seems to me, is how we meet these goals. I think it’s true that putting some limits on what information is released is probably necessary over certain periods of time. For example, I wouldn’t advocate opening the FOMC meetings to the public; I think that would not be terribly useful. On the other hand, Governor Warsh was just talking about perhaps releasing minutes earlier or faster or some version of them, maybe with incomplete detail, but including the tone and nature of the discussion. I think it could be fairly useful and informative, particularly if it noted disagreements or discussions in terms of where the tension happened to be within the meeting. I spent several months at the Bank of England a couple of years ago and watched the give and take among committee members at the MPC and also watched them go out in public and discuss their different views and why they disagreed with each other. That was very instructive to me because they did it without apparently adding to volatility in the marketplace. The market had come to accept the notion that these people disagreed on some things. The information released might differ depending on the type of monetary regime we think we’re in—whether in a regime of inflation targeting or one of full discretion. However, regardless of the regime, the need for policymakers to clearly communicate what their goals are, their understanding of the economy’s current economic conditions and expected future conditions, and then the reasons for their decisions is an important part of communication. As to the quantity of information, quantity and quality to me are intertwined, so I’m going to talk about both of them together. Again, I applaud the expedited release of the minutes. Instituting that was a tremendous step forward, and I think it’s a very good idea. However, I would favor the Committee’s releasing some additional pieces of information. I obviously favor stating an explicit definition of price stability because doing so would help clarify our goals. The current practice of citing the range and central tendency of members’ forecasts is fine, but I would favor our releasing more information, perhaps in a quarterly forecast or in something like an inflation report, to help convey to the marketplace and the public what our range of views is and where the Committee stands on the state of the economy. It might help the public’s assessment of our views if we based our forecasts on some underlying policy assumptions rather than on what one might call appropriate policy, which might differ from member to member obviously and would likely not be well understood by the public anyway. One suggestion that has already been mentioned is conditioning the forecasts on the market’s expected funds rate path, for example. But in some way stating our assumptions or projections about potential GDP would be important as well because that information, again, will help the markets and market participants understand where the Committee is coming from. In regard to forward-looking information, I think there are a number of things that the FOMC could and should communicate, but its current expectation about the future path of the fed funds rate is not one of them. I don’t think that’s a very good practice in general. However, I do think that what we need to do is talk more about what our goals are, what our forecasts of those goals are, and even more in a qualitative sense the process by which we think we’re going to get there. That is to say, talking about how monetary policy will respond to various events—I hesitate to use the phrase “decision rule”—wouldn’t necessarily say anything about the future path of the fed funds rate, but it would be very informative. It’s critical, as has already been mentioned, that the FOMC members agree on what the goals are. The members don’t need to agree on the model of the economy or the channel by which they think monetary policy actually operates. Indeed, given the state of economic science, the differences in models and channels can aid in policy formation. Similarly, since dissents at this meeting are public, dissenters should feel free to explain the reasons for their dissent. We shouldn’t discourage presidents and other members from expressing their views about the state of the economy and the process. Committee members should be free to indicate how their views on the economy are evolving. In fact, I think that doing so supports our goal of helping the public form sound expectations of what policy is actually going to be." CHRG-111hhrg53244--123 Mr. Bernanke," We will extend it if conditions warrant. And we will try to give the markets plenty of advance notice. We are not going to necessarily try to hit any particular number. We are going to have to make a judgment whether the conditions in markets are still sufficiently disrupted that such an intervention is necessary. Remember, this is based on a determination that conditions are unusual and exigent. And if markets normalize, we should no longer be using that kind of program. " CHRG-111hhrg49968--126 Mr. Bernanke," That is right. So this is a very serious problem. Because besides the very important fact that people without jobs have difficulty meeting their house payments and other bills, people who are out of the labor force for a few years tend to lose their skills, tend to lose their connection to the labor force, and maybe when the economy recovers they may not even be employable. It is possible. So there are a lot of costs involved in this. And if I had an easy answer, I would give it to you. All I can say is that, as you know, the Federal Reserve has been very aggressive in trying to support the economy, and the Congress has been as well. We might look at trying to help people retain their skills through educational programs or other kinds of training programs. Ms. Schwartz. So maybe while people are on unemployment, we might want to actually get them into other kinds of job training or education? " FOMC20071031meeting--64 62,MR. LOCKHART.," Thank you, Mr. Chairman. As I have noted in the past, the industrial mix in the Sixth District looks a lot like the country as a whole. The regional data and anecdotal information show that, although the Sixth District economy is still expanding, the pace is marginally weaker than it was in September. In earlier meetings I commented on the severity of the housing situation in the District. There is no improvement in sight for the housing market, and there are signs that the sharp decline in residential construction is spilling over into nonresidential real estate segments, such as shopping center development. Employment growth is softening as well. Although the largest negative effects are in construction-related sectors, the slowdown in job growth appears to be fairly broad based. The broad contour of our national forecast is similar to the Greenbook baseline. Like the Greenbook, our forecast includes a slowing in business investment. Based on our survey of District business contacts, it appears that the low levels of expected capital expenditure are due mainly to pessimism about the pace of economic activity rather than restrictive credit conditions per se. Specifically, financial market turbulence does not appear to have directly affected economic activity, but it has created a greater uncertainty about the outlook for the economy. As a consequence, the majority of my directors and business contacts are reporting very little in the way of plans to increase capital expenditures in the coming year. Where business investment is discretionary, most respondents report a wait-and-see posture. More positively, the weaker dollar does appear to be having a positive effect on exports from the region. For the year to date, the dollar value of exports through the Sixth District ports was up 35 percent through August, whereas import growth was only 21 percent. Not coincidentally, the majority of businesses that indicated they were increasing capital expenditures over the coming months were exporters. In the run-up to this FOMC meeting, I again made calls to a few financial market participants, and they reflected a range of institutional and market perspectives. A synthesis of this opinion is consistent with the views that were expressed earlier by Bill Dudley and others. There’s a widespread view that persistent volatility in credit markets is bound to negatively affect the general economy. Credit market conditions have improved somewhat, but stability may be a long way off. A second wave of volatility may accompany incoming details regarding mortgage delinquencies caused by rate resets in 2008, and there’s a suspicion that third-quarter writedowns may be followed by substantial further losses recognized at year-end. Also, as referenced in the Bluebook, there is skepticism about the M-LEC (master liquidity enhancement conduit) proposal from several angles. In summary, our soundings of the economy, informed by formal modeling work, point to a continued slowing of the economy that will likely persist well into next year. Anecdotally, credit constraints outside the housing sector do not appear to be a major factor at this stage. But uncertainty created by financial market turbulence does seem to be acting as a constraint, and I believe that the heightened uncertainty regarding the economic outlook for 2008 warrants consideration of insurance against this downside risk. With respect to the outlook for inflation, I agree with the view expressed by others that recent developments in energy prices, if they persist, make it likely that we are about to enter another period in which headline numbers substantially exceed the trends suggested by core measures. Because of this, I feel it’s appropriate to characterize inflation risk as having increased. Thank you, Mr. Chairman." CHRG-111hhrg48674--100 Mr. Bernanke," Congressman, I have a very open mind about this, and I think it is very important to understand what went wrong, and there are probably many elements that contributed to the crisis. I do not think the evidence supports the view that Federal Reserve monetary policy in the early part of this decade was the principal source of the crisis. I think the principal source of the crisis had to do with the huge capital inflows coming from our trade deficit which overwhelmed our system and made risk management inadequate. That being said, I think we need to review monetary policy and make sure in particular that we don't err in terms of leaving policy too easy too long. Now, whether inflation targets would have helped, I am not sure. One of the key proponents of this view that the Federal Reserve kept rates too low explains the worldwide nature of this crisis by saying all the other central banks did the same thing, and most of them had inflation targets. " fcic_final_report_full--139 Overall, while the mortgages behind the subprime mortgage–backed securities were often issued to borrowers that could help Fannie and Freddie fulfill their goals, the mortgages behind the Alt-A securities were not. Alt-A mortgages were not gener- ally extended to lower-income borrowers, and the regulations prohibited mortgages to borrowers with unstated income levels—a hallmark of Alt-A loans—from count- ing toward affordability goals.  Levin told the FCIC that they believed that the pur- chase of Alt-A securities “did not have a net positive effect on Fannie Mae’s housing goals.”  Instead, they had to be offset with more mortgages for low- and moderate- income borrowers to meet the goals. Fannie and Freddie continued to purchase subprime and Alt-A mortgage–backed securities from  to  and also bought and securitized greater numbers of riskier mortgages. The results would be disastrous for the companies, their share- holders, and American taxpayers. COMMISSION CONCLUSIONS ON CHAPTER 7 The Commission concludes that the monetary policy of the Federal Reserve, along with capital flows from abroad, created conditions in which a housing bub- ble could develop. However, these conditions need not have led to a crisis. The Federal Reserve and other regulators did not take actions necessary to constrain the credit bubble. In addition, the Federal Reserve’s policies and pronouncements encouraged rather than inhibited the growth of mortgage debt and the housing bubble. Lending standards collapsed, and there was a significant failure of accounta- bility and responsibility throughout each level of the lending system. This in- cluded borrowers, mortgage brokers, appraisers, originators, securitizers, credit rating agencies, and investors, and ranged from corporate boardrooms to individ- uals. Loans were often premised on ever-rising home prices and were made re- gardless of ability to pay. The nonprime mortgage securitization process created a pipeline through which risky mortgages were conveyed and sold throughout the financial system. This pipeline was essential to the origination of the burgeoning numbers of high- risk mortgages. The originate-to-distribute model undermined responsibility and accountability for the long-term viability of mortgages and mortgage-related se- curities and contributed to the poor quality of mortgage loans. (continues) (continued) FOMC20080318meeting--46 44,MR. STOCKTON.," We have thought about that, and the difficulty at this point is trying to identify the truly exogenous features of the current financial stress that is operating over and beyond the channels that are normally incorporated in our models. Our models, obviously, have asset prices, such as house prices and stock prices, and have interest rates and interest rate spreads, and as those things have changed, we have been able to incorporate them into our forecast. But then, over and above that, we think that the model doesn't really capture a lot of the credit-availability channels. There is a lot more stress in the market beyond that captured by the interest rates in our models. So taking this with more than a grain of salt, we think roughly � percentage point on the level of GDP this year--over and beyond the effects of lower house prices, the weaker stock market, and the higher interest rate spreads--that basically lingers on into next year and only then begins to gradually phase out. That is an important factor as to why this forecast is based on such a low real federal funds rate. Obviously, if you came to a different conclusion either about the depth of what is likely to be occurring in the next few months in terms of the restraint--not just from these financial stress conditions but also from our call that we are moving into a recession--or about the way that restraint fades out over the forecast, that would have a huge influence on the projected path for the funds rate. So it is important to recognize that this forecast is conditioned on one in which those effects linger quite significantly into next year. " CHRG-111hhrg56776--204 Mr. Bernanke," This has been one of our top priorities. It's very, very important. What you need to do here is get an appropriate balance, on the one hand, between making sure the banks are safe and sound, making good loans. On the other hand, making sure that credit-worthy borrowers can get credit, and that the economy can grow. So we need to find the appropriate balance there, and we have done that in a number of ways. We have taken the lead on issuing guidance to our examiners and to the banks on small business lending, on commercial real estate lending, where the emphasis is on finding that appropriate balance. And it's giving lots of examples to the banks and the examiners, where you can look at the example and it gives you some insight into what criteria to apply when you're looking at a loan. And, in particular, one point that we have made repeatedly is that just because the asset value underlying a loan, the collateral of the loan has gone down, doesn't mean that it's a bad loan. Because as long as the borrower can make the payments, that still can be a good loan, and we shouldn't penalize the banks for making those loans. So, we have issued those guidances, and we have done an enormous amount of training with our examiners to make sure they understand it. We have been gathering information and feedback from the field, including asking for more data and more information, but at each of the reserve banks around the country, having meetings that bring in small businesses, banks, and community leaders, to try and get into the details of what's going on. We have also tried to support the small business lending market with our TALF program, which has helped bring money from the securities markets into the small business lending arena. So it is a very important priority for us. We were asked before about the interaction between being responsible for the macro-economy and being a supervisor. Well, here is one case where knowing what's going on in the banking system is extremely important for understanding what's going on in the economy broadly. And we take that very seriously. So, I realize it's still an issue. It's going to be a concern, because certainly standards have tightened up. Certainly some people who were credit-eligible before are no longer eligible, because their financial conditions are worse. But we really think it's very important that credit-worthy borrowers be able to get credit, and we are working really hard on that. " CHRG-111shrg50815--14 Mr. Clayton," Thank you, Senator, members of the Committee. My name is Kenneth J. Clayton, Senior Vice President and General Counsel of the ABA Card Policy Council. I appreciate the opportunity to testify today. Credit cards are responsible for more than $2.5 trillion in transactions a year and are accepted in more than 24 million locations worldwide. It is mind boggling to consider the systems needed to handle 10,000 card transactions every second around the world. It is an enormous, complicated, and expensive structure, all dedicated to delivering the efficient, safe, and easy payment vehicle we have all come to enjoy. As the credit card market has evolved to provide greater benefits and broader access, it has become more complex. As a result, legitimate concerns have been raised about the adequacy of disclosures and other regulations. In response to these concerns, the Federal Reserve and two other regulators released comprehensive rules that fundamentally change the protections offered to cardholders. In many respects, these rules reflect the input from those on this Committee and others. They have heard you. Federal Reserve Chairman Ben Bernanke noted that the new rules were, and I quote, ``the most comprehensive and sweeping reforms ever adopted by the Board for credit card accounts.'' These changes have forced the complete reworking of the credit card industry's internal operations, pricing models, and funding mechanisms. As this Committee considers new restrictions on credit cards, it is important to understand the sweeping nature of the Fed's rule and the extent to which it has already addressed the core concerns of cardholders. The rule essentially eliminates many controversial card practices. For example, it eliminates the repricing of existing balances, including the use of universal default. It eliminates changes to interest rates for new balances for the first year that the card is in existence. It eliminates double-cycle billing. It eliminates payment allocation methods perceived to disadvantage customers. And it eliminates high up-front fees on subprime cards that confuse consumers over the amount of credit actually available. The rule likewise ensures that customers will have adequate time to pay their bills and adequate notice of any interest rate increase on future balances so they can act appropriately. Perhaps most importantly, the rule provides significant enhancements to credit card billing statements, applications, solicitations, and disclosures that ensure that consumers will have the information they want in a manner they will understand and in a format they will notice so they can take informed actions in their best interests. These new rules will have even broader implications for consumers, card issuers, and the general economy. The rules affect every aspect of the credit card business, from how cards are funded to how they are priced to how they are marketed and to how credit is allocated among customers with different credit histories and risk. For example, because of the limitations on the repricing of risk, the rules will reduce credit availability and increase the price of credit. The rule will also impact the ability of card lenders to fund consumer loans in the secondary market as pricing restrictions coupled with increased delinquencies in this recession make investors very wary of buying asset-backed securities backed by card receivables. These securities fund about half of all card loans, to the tune of $450 billion. This can have enormous implications for the U.S. economy going forward and it is why the Fed and Treasury are currently working hard to unlock this market. Finally, the rules will impose enormous operational challenges for card issuers. Card lenders must completely overhaul internal processes, software, billing, product lines, advertising, customer service, and a host of other internal workings. Risk management models must be completely revised. The Fed understood the enormity of this challenge and stressed that adequate time to implement it is critical to avoid significant harm to consumers, and I want to stress that last point about the harm to consumers because there is a real concern that moving the date up on some of these rules will actually end up harming the consumers more than it benefits them. In closing, we would urge that any discussion over further legislation in this area be viewed in the context of the recent Federal Reserve rule, recognizing its sweeping nature, protection to consumers, impact on operations, and most importantly, its potential impact on our broader economy and the provision of credit to consumers and small businesses. Thank you. I would be happy to answer any questions you have. " Chairman Dodd," [Presiding.] Thank you very much. I appreciate your testimony and your presence here. Did you introduce all the witnesses? Senator Johnson. Yes. " FOMC20070321meeting--207 205,MR. KROSZNER.," As I said in my discussion, obviously I’m very concerned about a reference to financial conditions, especially “still-favorable financial conditions.” But as I also said, I think that it hangs out there a bit naked without some color around it. I would be fine with keeping personal income gains and the gradually waning correction to the housing market. My preference would be just something like “income gains, among other factors” to put something there. But that may be so weak that it may be better to cut off. I’m sympathetic to having some color, but I think the wrong color is the financial market condition." CHRG-110shrg50414--74 Mr. Bernanke," I do, Senator, but let me just add a couple comments. As you know, I am a student of financial crises and financial history, and we have looked at past experiences in the United States and other countries, like the Homeowners Loan Corporation, the RTC, the RFC, Japan, other situations. Those were all situations, again, as the Secretary said, where you were dealing with failed institutions and having to dispose of relatively simple assets that were taken over by the Government. That works in that context, and there are ways to do that. The situation we have now is unique and new. It involves not failing institutions--although we have had a few failures. Where we had failures, we dealt with them in a very tough way. You know, we have insisted on, you know, bringing the shareholder value down close to zero, imposing tough terms and so on. But the firms we are dealing with now are not necessarily failing, but they are contracting, they are de-leveraging, they are pulling back. And they will be unwilling to make credit available as long as these market conditions are in the condition they are. So, in order to address the illiquidity of the market and how to deal with these complex securities in the hands of going concerns, the methods used to resolve failed institutions in other contexts are not really appropriate because that would involve, I think, a great deal of concern on the part of other potential investors that if they invest in a bank that the Government is going to come in and take away their value. So I think that we are better off trying to address the root cause of the problem. Senator Shelby. What banks would be eligible to participate in this plan, assuming Congress adopted it as you proposed it, in selling their nonperforming assets to the Treasury or to an entity? And what size banks would be eligible to participate in that plan? " fcic_final_report_full--520 Finally, in a December 21, 2007, letter to Brian Montgomery, Assistant Secretary of Housing, Fannie CEO Daniel Mudd asked that, in light of the financial and economic conditions then prevailing in the country—particularly the absence of a PMBS market and the increasing number of mortgage delinquencies and defaults— HUD’s AH goals for 2007 be declared “infeasible.” He noted that HUD also has an obligation to “consider the financial condition of the enterprise when determining the feasibility of goals.” Then he continued: “Fannie Mae submits that the company took all reasonable actions to meet the subgoals that were both financially prudent and likely to contribute to the achievement of the subgoals…. In 2006, Fannie Mae relaxed certain underwriting standards and purchased some higher risk mortgage loan products in an effort to meet the housing goals. The company continued to purchase higher risk loans into 2007, and believes these efforts to acquire goals-rich loans are partially responsible for increasing credit losses.” 133 [emphasis supplied] This statement confirms two facts that are critical on the question of why Fannie (and Freddie) acquired so many high risk loans in 2006 and earlier years: first, the companies were trying to meet the AH goals established by HUD and not because these loans were profitable. It also shows that the efforts of HUD and others— including the Commission majority in its report—to blame the managements of Fannie and Freddie for purchasing the loans that ultimately dragged them to insolvency is misplaced. Finally, in a July 2009 report, the Federal Housing Finance Agency (FHFA, the GSEs’ new regulator, replacing OFHEO), noted that Fannie and Freddie both followed the practice of cross-subsidizing the subprime and Alt-A loans that they acquired: Although Fannie Mae and Freddie Mac consider model-derived estimates of cost in determining the single-family guarantee fees they charge, their pricing often subsidizes their guarantees on some mortgages using higher returns they expect to earn on guarantees of other loans. In both 2007 and 2008, cross-subsidization in single-family guarantee fees charged by the Enterprises was evident across product types, credit score categories, and LTV ratio categories. In each case, there were cross- subsidies from mortgages that posed lower credit risk on average to loans that posed higher credit risk. The greatest estimated subsidies generally went to the highest-risk mortgages. 134 The higher risk mortgages were the ones most needed by Fannie and Freddie to meet the AH goals. Needless to say, there is no need to cross-subsidize the G-fees of loans that are acquired because they are profitable. Accordingly, both market share and profitability must be excluded as reasons that Fannie (and Freddie) acquired subprime and Alt-A loans between 2004 and 131 132 133 134 Fannie Mae, “Housing Goals Forecast,” Alignment Meeting, June 22, 2007. Fannie Mae, Forecast Meeting, July 27, 2007 slide 4. Fannie Mae letter, Daniel Mudd to Asst. Secretary Brian Montgomery, December 21, 2007, p.6. FHFA, Fannie Mae and Freddie Mac Single Family Guarantee Fees in 2007 and 2008, p.33. 2007. The only remaining motive—and the valid one—was the effect of the AH goals imposed by HUD. CHRG-110shrg38109--36 Chairman Bernanke," Thank you, Mr. Chairman. The very important drivers of economic growth and prosperity in this country include free and open trade and technological progress. It is very important to allow those forces to continue to operate in our economy. However, we do have to recognize, as I discussed in Omaha, that the effects of these forces can be differential across the population. They may create greater income possibilities for some than others. They may create painful dislocations, for example, if the composition of industries changes or job skill requirements change. I agree with Chairman Greenspan's general point that in order to support and retain support for policies of free trade, open borders, technological change, flexible labor markets, we need to make sure that the gains and benefits from these powerful, growth-producing forces are broadly shared and that people understand that these things are good for the American economy and good for people generally in the economy. How to do that is very difficult. It is easy enough to say let us promote economic opportunity. I certainly support that idea. Doing it is not necessarily easy. I discussed in my speech some general issues and approaches, including education, not only K-12 education but also training throughout the life span, from early childhood through adult retraining. We need to help people who are dislocated by these powerful dynamic forces to find new jobs, to find new opportunities. I think that is very important. I would just say, though, that I am glad you did not ask me to endorse specific policies, because making that work in practice is difficult. We have to find ways to achieve these objectives. For example, retraining workers in ways that are effective, and are effective in terms of the spending that we put into it. So it is a great challenge for us going forward to look among all the possible approaches and decide which types of programs, which types of initiatives will be most effective at achieving this objective. That being said, again, I do agree that we need to spread the benefits widely and make people understand that open trade and technological change are beneficial for not only the economy in the aggregate, but also for the great majority of people in the economy. " FOMC20070918meeting--107 105,MR. LOCKHART.," Thank you, Mr. Chairman. In the Sixth District, we indulge ourselves with the conceit that our District looks a lot like the nation as a whole. We have 45 million consumers and an industrial composition that does resemble the country, so you can process my regional remarks with that conceit in mind. Housing markets continued to deteriorate in August in the Sixth District. Housing market weakness was most pronounced in Florida, as you might expect, followed by Atlanta and middle Tennessee. The consensus view is that the recent tightening in mortgage credit availability will exacerbate the region’s housing market problems, and most regional contacts believe that housing markets will continue to weaken, bottoming out no earlier than mid-2008, and some see a much longer adjustment period. Aside from housing, real economic readings in the Sixth District were mixed. Anecdotal feedback across a number of industries suggested that business spending has not yet slowed markedly, but the majority of contacts indicated that they are now approaching new capital spending more cautiously. That said, most contacts acknowledge that tighter credit standards have not significantly affected business capital investment outlays. Reports of factory activity were mixed, with defense and export industries doing well, while industries linked to housing were predictably weak. Transportation contacts indicated ongoing weak domestic demand. Consumer activity in the District was flat to slightly up in August compared with a year ago. Housing-related home product sales were especially weak, as were auto sales. Perhaps the most notable change from previous months was a turn to pessimism on the part of directors, reflecting their soundings of business contacts in their communities. I will mention that we have five Branches, so we actually get director feedback from more than forty directors across the District. Sixty percent believe that economic activity will be slower six months out, twice the percentage recorded in July. Even factoring out idiosyncratic conditions in localities such as south Florida and the Gulf Coast, the outlook, based on these anecdotal reports, has turned to the negative. To summarize my regional comments—current fundamentals are mixed, and the outlook is pessimistic. In our view, the economic outlook has changed since the last meeting, and the balance of risk has clearly shifted to the downside. We do not see a near-term recession as a high likelihood, but we do anticipate that growth will approach trend much more slowly with employment edging up as a consequence. So in direction and tone, if not magnitude, we are in agreement with the Greenbook, but our forecast differs from the Greenbook baseline forecast in the depth of the below-trend growth, ours being somewhat milder because we condition our forecast on deeper cumulative cuts in the fed funds rate over the coming months. Turning to capital markets, my recent conversations with a number of capital market participants suggest that the adjustment process in financial markets is far from complete. Their anecdotal feedback reflects a range of views about the severity of the current problems and the outlook for stabilization. Here is the overall picture I gleaned from these conversations. Some debt markets have firmed a bit. The leveraged-loan market, for example, is likely to renew trading in the coming weeks, but structured-debt security markets are not yet clearing. The principal reason—and this has been mentioned earlier by Bill and others—that debt markets remain illiquid is weak counterparty transparency and, therefore, uncertain counterparty risk, as well as uncertainty regarding the performance of collateral pools that back securities. The process of achieving adequate clarity and stabilization of the markets will likely take many more weeks. Markets will remain volatile while the condition of heightened uncertainty persists. There has been some spillover into markets that are unrelated to structured debt and subprime, but creditworthy borrowers are getting credit. There is sufficient buyer liquidity currently on the sidelines awaiting greater clarity regarding counterparties, market pricing of securities, and the depth and scope of the difficulties. Widespread deleveraging, particularly by SIVs and hedge funds and nonbank entities, is occurring and is likely to continue. One party argued, however, that all the news of financial distress has not pushed risk spreads to the extremes of historical bands. This party argued, “We are experiencing a painful adjustment from excessively high leverage to more-rational or more-realistic pricing in line with historical averages.” But all contacts believe—and this is perhaps not unexpected—that prolonged credit market problems will affect the broad economy, mostly through the consumer credit channel. So I believe our decision today boils down to whether we cut ¼ percentage point or ½ percentage point, obviously in combination with careful wording of the statement that conveys a rationale focused on economic fundamentals while signaling some recognition that the problems in the capital markets have the potential to deliver a credit shock to the broad economy. I consider it appropriate to adjust the federal funds rate to the now-weaker economic outlook, and I support a 50 basis point move with the rationale that at least 25 basis points of that represents recognition of a lower equilibrium rate and the remainder is a preemptive, preventive measure designed to renew confidence, facilitate conditions that resolve uncertainty, and shorten the necessary adjustment timeline in a deleveraging financial sector. It is a fair question whether the process of information revelation—that is, removing uncertainty—will be accelerated by an aggressive rate cut. My view is that this action, along with other liquidity actions, removes the psychological barrier—that being the concern that the Fed might fail to ensure enough upfront liquidity and might be pursuing an inadvertently tight policy, compounding problems by putting undue stress on the real economy. I think a distinction can be drawn between trying to influence the psychology around dangerous financial sector circumstances and bailing out the markets, and care should be taken to reflect this in the minutes. Let me add that I agree with the earlier comments of President Fisher that we perhaps should be looking at any policy move in the context of a total package that includes the auction credit facility. So I do have, let’s say, some sympathy for the view that the total package must be discussed. Thank you, Mr. Chairman." CHRG-110hhrg41184--22 Mr. Bernanke," Yes, I will. The Reg Z regulations are still out for comment. We are receiving comments, which we are going to review very carefully. But the intent of Reg Z was to provide clearer disclosure so people could understand what their credit card account involved. In particular, we have created a new Schumer Box, as it is called. It has new information about fees and penalties and provides more information to the consumer about the terms and conditions of their account. In addition, we propose to lengthen the period of time over which a consumer must receive notice before there is a change in terms of their credit card. These disclosures have been consumer tested. We have used companies to go out and use actual consumers to see what works, how much they recall, how much they understand. And we think there will be a substantial improvement in terms of allowing people to understand what is involved in their credit card accounts. We are beginning, as I mentioned, to look at some practices under the Unfair and Deceptive Acts and Practices rules. We anticipate setting out a proposal for comments within a couple of months, this spring, to address some issues that the disclosure rules themselves cannot address. The final release of both sets of rules will probably take place later this year. If possible, to minimize burden on the industry, would be to release the Reg Z disclosures and the new rules on unfair and deceptive acts and practices at about the same time, if possible. So I don't have a specific date yet for that release. " CHRG-111hhrg56767--72 Mr. Feinberg," Very high, but Fannie and Freddie, although they are not on my watch, pose some unique problems that I do not have to address with the five companies I am now dealing with. First, the future of Fannie and Freddie is sufficiently uncertain, as you well know, so that attracting people to Fannie and Freddie with the talent necessary to administer that program is more problematic. Not impossible, of course, but more problematic. Second, it is not easy to develop a pay package that has long-term performance-based delay, like I have with the five companies before me, when long-term performance-based delay is uncertain with a company like Fannie and Freddie. You cannot simply say, we will pay you over 4 or 5 years out, when there is a question as to what Fannie and Freddie will look like 4 or 5 years out. Finally, a major component of what I am doing and what the Office of the Special Master is doing is tied to stock. The fortunes of the individual will depend on the fortunes of the company. Your stock's value will depend on how well the company is doing. With Fannie and Freddie, there is no stock. It is cash. " CHRG-111shrg50814--205 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System February 24, 2009 Chairman Dodd, Senator Shelby, and members of the Committee, I appreciate the opportunity to discuss monetary policy and the economic situation and to present the Federal Reserve's Monetary Policy Report to the Congress.Recent Economic and Financial Developments and the Policy Responses As you are aware, the U.S. economy is undergoing a severe contraction. Employment has fallen steeply since last autumn, and the unemployment rate has moved up to 7.6 percent. The deteriorating job market, considerable losses of equity and housing wealth, and tight lending conditions have weighed down consumer sentiment and spending. In addition, businesses have cut back capital outlays in response to the softening outlook for sales as well as the difficulty of obtaining credit. In contrast to the first half of last year, when robust foreign demand for U.S. goods and services provided some offset to weakness in domestic spending, exports slumped in the second half as our major trading partners fell into recession and some measures of global growth turned negative for the first time in more than 25 years. In all, U.S. real gross domestic product (GDP) declined slightly in the third quarter of 2008, and that decline steepened considerably in the fourth quarter. The sharp contraction in economic activity appears to have continued into the first quarter of 2009. The substantial declines in the prices of energy and other commodities last year and the growing margin of economic slack have contributed to a substantial lessening of inflation pressures. Indeed, overall consumer price inflation measured on a 12-month basis was close to zero last month. Core inflation, which excludes the direct effects of food and energy prices, also has declined significantly. The principal cause of the economic slowdown was the collapse of the global credit boom and the ensuing financial crisis, which has affected asset values, credit conditions, and consumer and business confidence around the world. The immediate trigger of the crisis was the end of housing booms in the United States and other countries and the associated problems in mortgage markets, notably the collapse of the U.S. subprime mortgage market. Conditions in housing and mortgage markets have proved a serious drag on the broader economy both directly, through their impact on residential construction and related industries and on household wealth, and indirectly, through the effects of rising mortgage delinquencies on the health of financial institutions. Recent data show that residential construction and sales continue to be very weak, house prices continue to fall, and foreclosure starts remain at very high levels. The financial crisis intensified significantly in September and October. In September, the Treasury and the Federal Housing Finance Agency placed the government-sponsored enterprises, Fannie Mae and Freddie Mac, into conservatorship, and Lehman Brothers Holdings filed for bankruptcy. In the following weeks, several other large financial institutions failed, came to the brink of failure, or were acquired by competitors under distressed circumstances. Losses at a prominent money market mutual fund prompted investors, who had traditionally considered money market mutual funds to be virtually risk-free, to withdraw large amounts from such funds. The resulting outflows threatened the stability of short-term funding markets, particularly the commercial paper market, upon which corporations rely heavily for their short-term borrowing needs. Concerns about potential losses also undermined confidence in wholesale bank funding markets, leading to further increases in bank borrowing costs and a tightening of credit availability from banks. Recognizing the critical importance of the provision of credit to businesses and households from financial institutions, the Congress passed the Emergency Economic Stabilization Act last fall. Under the authority granted by this act, the Treasury purchased preferred shares in a broad range of depository institutions to shore up their capital bases. During this period, the Federal Deposit Insurance Corporation (FDIC) introduced its Temporary Liquidity Guarantee Program, which expanded its guarantees of bank liabilities to include selected senior unsecured obligations and all non-interest-bearing transactions deposits. The Treasury--in concert with the Federal Reserve and the FDIC--provided packages of loans and guarantees to ensure the continued stability of Citigroup and Bank of America, two of the world's largest banks. Over this period, governments in many foreign countries also announced plans to stabilize their financial institutions, including through large-scale capital injections, expansions of deposit insurance, and guarantees of some forms of bank debt. Faced with the significant deterioration in financial market conditions and a substantial worsening of the economic outlook, the Federal Open Market Committee (FOMC) continued to ease monetary policy aggressively in the final months of 2008, including a rate cut coordinated with five other major central banks. In December the FOMC brought its target for the federal funds rate to a historically low range of 0 to \1/4\ percent, where it remains today. The FOMC anticipates that economic conditions are likely to warrant exceptionally low levels of the Federal funds rate for some time. With the Federal funds rate near its floor, the Federal Reserve has taken additional steps to ease credit conditions. To support housing markets and economic activity more broadly, and to improve mortgage market functioning, the Federal Reserve has begun to purchase large amounts of agency debt and agency mortgage-backed securities. Since the announcement of this program last November, the conforming fixed mortgage rate has fallen nearly 1 percentage point. The Federal Reserve also established new lending facilities and expanded existing facilities to enhance the flow of credit to businesses and households. In response to heightened stress in bank funding markets, we increased the size of the Term Auction Facility to help ensure that banks could obtain the funds they need to provide credit to their customers, and we expanded our network of swap lines with foreign central banks to ease conditions in interconnected dollar funding markets at home and abroad. We also established new lending facilities to support the functioning of the commercial paper market and to ease pressures on money market mutual funds. In an effort to restart securitization markets to support the extension of credit to consumers and small businesses, we joined with the Treasury to announce the Term Asset-Backed Securities Loan Facility (TALF). The TALF is expected to begin extending loans soon. The measures taken by the Federal Reserve, other U.S. Government entities, and foreign governments since September have helped to restore a degree of stability to some financial markets. In particular, strains in short-term funding markets have eased notably since the fall, and London interbank offered rates (Libor)--upon which borrowing costs for many households and businesses are based--have decreased sharply. Conditions in the commercial paper market also have improved, even for lower-rated borrowers, and the sharp outflows from money market mutual funds seen in September have been replaced by modest inflows. Corporate risk spreads have declined somewhat from extraordinarily high levels, although these spreads remain elevated by historical standards. Likely spurred by the improvements in pricing and liquidity, issuance of investment-grade corporate bonds has been strong, and speculative-grade issuance, which was near zero in the fourth quarter, has picked up somewhat. As I mentioned earlier, conforming fixed mortgage rates for households have declined. Nevertheless, despite these favorable developments, significant stresses persist in many markets. Notably, most securitization markets remain shut, other than that for conforming mortgages, and some financial institutions remain under pressure. In light of ongoing concerns over the health of financial institutions, the Secretary of the Treasury recently announced a plan for further actions. This plan includes four principal elements: First, a new capital assistance program will be established to ensure that banks have adequate buffers of high-quality capital, based on the results of comprehensive stress tests to be conducted by the financial regulators, including the Federal Reserve. Second is a public-private investment fund in which private capital will be leveraged with public funds to purchase legacy assets from financial institutions. Third, the Federal Reserve, using capital provided by the Treasury, plans to expand the size and scope of the TALF to include securities backed by commercial real estate loans and potentially other types of asset-backed securities as well. Fourth, the plan includes a range of measures to help prevent unnecessary foreclosures. Together, over time these initiatives should further stabilize our financial institutions and markets, improving confidence and helping to restore the flow of credit needed to promote economic recovery.Federal Reserve Transparency The Federal Reserve is committed to keeping the Congress and the public informed about its lending programs and balance sheet. For example, we continue to add to the information shown in the Fed's H.4.1 statistical release, which provides weekly detail on the balance sheet and the amounts outstanding for each of the Federal Reserve's lending facilities. Extensive additional information about each of the Federal Reserve's lending programs is available online. \1\The Fed also provides bimonthly reports to the Congress on each of its programs that rely on the section 13(3) authorities. Generally, our disclosure policies reflect the current best practices of major central banks around the world. In addition, the Federal Reserve's internal controls and management practices are closely monitored by an independent inspector general, outside private-sector auditors, and internal management and operations divisions, and through periodic reviews by the Government Accountability Office.--------------------------------------------------------------------------- \1\ For links and references, see Ben S. Bernanke (2009), ``Federal Reserve Programs to Strengthen Credit Markets and the Economy,'' testimony before the Committee on Financial Services, U.S. House of Representatives, February 10, http://www.federalreserve.gov/newsevents/testimony/bernanke20090210a.htm--------------------------------------------------------------------------- All that said, we recognize that recent developments have led to a substantial increase in the public's interest in the Fed's programs and balance sheet. For this reason, we at the Fed have begun a thorough review of our disclosure policies and the effectiveness of our communication. Today I would like to highlight two initiatives. First, to improve public access to information concerning Fed policies and programs, we recently unveiled a new section of our Web site that brings together in a systematic and comprehensive way the full range of information that the Federal Reserve already makes available, supplemented by explanations, discussions, and analyses. \2\ We will use that Web site as one means of keeping the public and the Congress fully informed about Fed programs.--------------------------------------------------------------------------- \2\ The Web site is located at http://www.federalreserve.gov/monetarypolicy/bst.htm--------------------------------------------------------------------------- Second, at my request, Board Vice Chairman Donald Kohn is leading a committee that will review our current publications and disclosure policies relating to the Fed's balance sheet and lending policies. The presumption of the committee will be that the public has a right to know, and that the nondisclosure of information must be affirmatively justified by clearly articulated criteria for confidentiality, based on factors such as reasonable claims to privacy, the confidentiality of supervisory information, and the need to ensure the effectiveness of policy.The Economic Outlook and the FOMC's Quarterly Projections In their economic projections for the January FOMC meeting, monetary policy makers substantially marked down their forecasts for real GDP this year relative to the forecasts they had prepared in October. The central tendency of their most recent projections for real GDP implies a decline of \1/2\ percent to 1\1/4\ percent over the four quarters of 2009. These projections reflect an expected significant contraction in the first half of this year combined with an anticipated gradual resumption of growth in the second half. The central tendency for the unemployment rate in the fourth quarter of 2009 was marked up to a range of 8\1/2\ percent to 8\3/4\ percent. Federal Reserve policymakers continued to expect moderate expansion next year, with a central tendency of 2\1/2\ percent to 3\1/4\ percent growth in real GDP and a decline in the unemployment rate by the end of 2010 to a central tendency of 8 percent to 8\1/4\ percent. FOMC participants marked down their projections for overall inflation in 2009 to a central tendency of \1/4\ percent to 1 percent, reflecting expected weakness in commodity prices and the disinflationary effects of significant economic slack. The projections for core inflation also were marked down, to a central tendency bracketing 1 percent. Both overall and core inflation are expected to remain low over the next 2 years. This outlook for economic activity is subject to considerable uncertainty, and I believe that, overall, the downside risks probably outweigh those on the upside. One risk arises from the global nature of the slowdown, which could adversely affect U.S. exports and financial conditions to an even greater degree than currently expected. Another risk derives from the destructive power of the so-called adverse feedback loop, in which weakening economic and financial conditions become mutually reinforcing. To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets. If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability--and only if that is the case, in my view--there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery. If financial conditions improve, the economy will be increasingly supported by fiscal and monetary stimulus, the salutary effects of the steep decline in energy prices since last summer, and the better alignment of business inventories and final sales, as well as the increased availability of credit. To further increase the information conveyed by the quarterly projections, FOMC participants agreed in January to begin publishing their estimates of the values to which they expect key economic variables to converge over the longer run (say, at a horizon of 5 or 6 years), under the assumption of appropriate monetary policy and in the absence of new shocks to the economy. The central tendency for the participants' estimates of the longer-run growth rate of real GDP is 2\1/2\ percent to 2\3/4\ percent; the central tendency for the longer-run rate of unemployment is 4\3/4\ percent to 5 percent; and the central tendency for the longer-run rate of inflation is 1\3/4\ percent to 2 percent, with the majority of participants looking for 2 percent inflation in the long run. These values are all notably different from the central tendencies of the projections for 2010 and 2011, reflecting the view of policymakers that a full recovery of the economy from the current recession is likely to take more than 2 or 3 years. The longer-run projections for output growth and unemployment may be interpreted as the Committee's estimates of the rate of growth of output and the unemployment rate that are sustainable in the long run in the United States, taking into account important influences such as the trend growth rates of productivity and the labor force, improvements in worker education and skills, the efficiency of the labor market at matching workers and jobs, government policies affecting technological development or the labor market, and other factors. The longer-run projections of inflation may be interpreted, in turn, as the rate of inflation that FOMC participants see as most consistent with the dual mandate given to it by the Congress--that is, the rate of inflation that promotes maximum sustainable employment while also delivering reasonable price stability. This further extension of the quarterly projections should provide the public a clearer picture of the FOMC's policy strategy for promoting maximum employment and price stability over time. Also, increased clarity about the FOMC's views regarding longer-run inflation should help to better stabilize the public's inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low. At the time of our last Monetary Policy Report, the Federal Reserve was confronted with both high inflation and rising unemployment. Since that report, however, inflation pressures have receded dramatically while the rise in the unemployment rate has accelerated and financial conditions have deteriorated. In light of these developments, the Federal Reserve is committed to using all available tools to stimulate economic activity and to improve financial market functioning. Toward that end, we have reduced the target for the Federal funds rate close to zero and we have established a number of programs to increase the flow of credit to key sectors of the economy. We believe that these actions, combined with the broad range of other fiscal and financial measures being put in place, will contribute to a gradual resumption of economic growth and improvement in labor market conditions in a context of low inflation. We will continue to work closely with the Congress and the Administration to explore means of fulfilling our mission of promoting maximum employment and price stability. FOMC20080430meeting--108 106,MR. STERN.," Thank you, Mr. Chairman. Well, for some time I have been using the headwinds period of the early 1990s as a frame of reference for thinking about credit conditions, economic growth, and inflation prospects for the next several years. I won't belabor that comparison much this afternoon, except to say that I continue to find it helpful. With that, and given that the information we have received since our March meeting hasn't caused me to change my views about financial conditions or about growth, let me just say that I continue to expect financial headwinds of some intensity to persist well into next year. I think that the economy will decline--contract in this quarter and in the next quarter--before growth resumes, and that the resumption will initially be fairly mild. So my outlook for economic growth next year is below that of the Greenbook. It is a pretty modest outlook. Recent anecdotes from business contacts and from people in financial services firms have not been what I would call overly negative. If I were to give those anecdotes more weight, I would probably be somewhat more optimistic about the economic outlook than I am. But I am guessing that those anecdotes are underestimating the weight of the credit constraints that are in train, and people--at least people that I have talked to--don't fully appreciate that yet. Turning to inflation, on average it seems to me that the inflation situation and its prospects are no better, and possibly worse, than I had been anticipating. To be sure, the core measures of inflation have not accelerated recently and look to be what I might call close to acceptable, looking at their recent performance. But we have been warned that some of that better performance is likely to prove transitory. Meanwhile, headline inflation has been elevated and has tended to surprise on the upside. Moreover, I worry that the persistence of sizable increases in energy and general commodity prices will have a more pronounced effect on core inflation going forward than they have in the recent past. Further, I have the sense, both from some estimates of inflation expectations and from the comments and questions I have been getting about inflation and the foreign exchange value of the dollar, that the public's conviction about monetary policy's willingness and ability to maintain low inflation is starting to waver. Thank you. " FOMC20080430meeting--104 102,MR. HOENIG.," Thank you, Mr. Chairman. Economic activity continues to be slow in the Tenth District with a soft tone in our residential and nonresidential construction and certainly in our retail sales. Mitigating this weakness, however, to some extent is continued strength in energy and agriculture exports and, to a lesser degree, manufacturing. With regard to exports, one interesting development is a shortage of shipping containers domestically and internationally that is limiting the volume of exports of both our agricultural and some of our manufacturing products. On balance though, the District activity continues to be stronger than the national economy, and this is reflected in better employment growth and firm labor markets in many parts of our region. In my recent discussions with directors at our Bank and in our Branches and the Economic Advisory Council members, several themes have been prominent. Concern about inflation has escalated to the highest level I've been involved with in the last decade. Businesses across the board are experiencing the largest input cost pressures in recent memory for them. Many businesses have not been able to absorb these cost pressures and have raised prices to both retail and business customers, and generally speaking, businesses are finding much less resistance to price increases than in the past. Businesses also report that suppliers are increasingly reluctant to make contractual price quotes very far in the future. We have also been monitoring the effects of credit availability on business capital spending in our area. Although businesses report some tightening of credit conditions, credit costs and availability are not the primary factors behind reduced capital spending plans. Bank loans have actually continued to grow. Instead, businesses cite uncertainty about the economic outlook as the main impediment to investment. They are in a wait-and-see mode. So spending is being held back not for financial reasons but just caution. Indeed, they suggest that uncertainty about whether monetary policy will be eased further is a factor currently inhibiting their capital spending plans. They want to see when we're done. Turning to the broader economic output and the national economy, I have revised down my growth estimate for the first half of 2008 but have had few changes to my longer-term outlook. Compared with the Greenbook, I see somewhat stronger growth this year and somewhat weaker growth next year. Weaker growth in the first half of this year is coming largely from the effects of higher energy prices on consumer and business spending coupled with the continued weakness in residential construction. I would say that the effect of high energy prices is now about as large as or even larger than the contraction in residential construction, and I think that the energy outlook constitutes a main downside risk to growth in the period ahead. In contrast--and contrary to the Greenbook and the views of some--I think that energy and housing perhaps now more than credit problems are holding back economic growth. Certainly credit conditions have continued to tighten as reflected in the April Senior Loan Officer Opinion Survey, and markets for many asset-backed securities, of course, have shut down. But the availability of credit for good business and household borrowers does not appear to have really been restricted that much. They are pricing more wisely for risk, and that is probably a positive. Consequently, the downside economic risks from a pronounced credit contraction appear to have diminished considerably over the past few months. I want to turn to inflation. In my view, the inflation outlook has worsened considerably. For the first time in many years, we are seeing significant inflation pressure from goods prices, especially imported goods prices. Moreover, the recent moderation in monthly inflation numbers is coming mainly from some softness in service prices, which in my opinion, is unlikely to continue. More optimistic views of inflation, including those in the Greenbook, rely heavily on economic slack and a turnaround in food and energy prices to improve the outlook. I am skeptical on both counts. I do not think that there will be as much slack generated in the current slowdown as does the Greenbook, and there is evidence that the effects of output and employment gaps on inflation have fallen, well, actually more than a little over the past two decades. Furthermore, I have not seen any indication that elevated energy and food price inflation is likely to dissipate soon, as many of these pressures are reflective of international economic developments that we have talked about here, including the weakness in the dollar. I believe that we are entering a dangerous period, if I can use that word, in which inflation expectations are beginning to move higher and inflation psychology is becoming more prominent in business decisions. In this regard, I also do not take much comfort from favorable readings of labor costs as wages tend to follow prices in my experience. In these circumstances, I am concerned that maintaining a highly accommodative policy stance for an extended period would greatly increase the likelihood that inflation exceeds our long-run objectives. Thank you. " FOMC20080109confcall--26 24,MS. YELLEN.," Thank you, Mr. Chairman. I agree with both the concerns that you expressed and the analysis that you offered. Based on the data we now have in hand, I support a 50 basis point reduction in the federal funds rate in the near future. I think a very good case can be made for moving down 25 basis points today, and it would be my preference. According to what Bill Dudley said, markets apparently do attach some probability to a move of that magnitude before the January meeting. I could also support a 50 basis point move today, but I am concerned that it might be taken as a sign of panic by the Committee and somehow wrongly indicate that we have inside information showing that things are even worse than markets already think or, alternatively, be seen as an overreaction to the employment report. But if we don't move today, I do think we need to take decisive action in January, and I hope you will give a strong signal that we will do so in your speech. I agree with the staff's assessment that the outlook for economic growth has weakened since December, and I also see the downside risks to the forecast as having increased since then. We have revised down our 2008 forecast also because of the sharp increase in energy prices and the deterioration we have seen in financial conditions just since December. It is good that conditions in money markets have improved somewhat, but equity prices have fallen very substantially--I guess around 6 percent since our last meeting. Credit spreads are up, and borrowing rates for many borrowers are higher in spite of a decline in Treasury yields. I also find the labor market developments worrisome. I try not to put too much weight on any single monthly observation, but I find it entirely believable and consistent with everything else we are seeing that we have entered, at best, a period of slow employment growth. It is something that we have been expecting all along. It helps to resolve some of the puzzles we have been discussing about why labor markets have been so strong relative to goods markets. It is true that consumer spending has been amazingly robust so far, but I find it unimaginable that it can continue when slow growth in disposable income is added to everything else that is weighing on households, particularly rising energy prices, accelerating declines in house prices, and falling stock prices. It seems to me that, with the stagnant or contracting labor market, the odds of a recession--and, as you argued, a potentially very nasty one--have risen. I am also very worried about the possibility of a credit crunch if higher job losses begins to make lenders pull back credit. It is true that on the inflation front the recent news hasn't been particularly good. It certainly is true that there are upside risks. But I do take comfort from the fact that inflation compensation has remained well behaved and that we already have slack in the labor market and more seems likely to develop. I support a significant rate cut not only because of the downgrade to the economic forecast since December but also because I think the stance of policy even now with the actions we have taken--I agree with you--is still within the neutral range. Given current prospects and the asymmetric nature of the risks, particularly the high tail risk associated with the credit crunch, I believe that policy should be clearly accommodative. So having revised down my forecast, I would support a significant funds rate cut as a way to catch up with where policy should be. " CHRG-110shrg50418--80 Mr. Wagoner," I just want--your comment about the 2003, 2004, 2005 period, I think it was a period that in retrospect was definitely fueled by low-cost credit, ready availability of credit to just about anybody who wanted it under, frankly, looser terms than probably would have been appropriate in retrospect. I think the wealth that was in the housing market, or perceived wealth, I think a lot of that was taken out by people with home equity loans and they would trade up and buy vehicles. And then I would have to say, within the industry, we had a bit of a structural issue, which I know from GM's side we had a lot of employees. We had huge cash obligations. I mentioned we owed $103 billion, or we paid over a certain period that in health care. And so the pressure to keep revenues quite high, and I think the learning from that period is we really have had to significantly reduce our structural costs so we don't have to force, if you will, try to push a string when the market isn't really there. And second of all, we are all going to have to adapt to a period of, I think, not only much more realistic credit terms, which means much less leasing, needing customers to offer some sort of downpayments, but we are also going to have to stick on this path that while energy prices have plummeted here recently, we don't for a second believe that that is a long-term situation. It is driven by the current credit crisis, and eventually with the growing demand for autos around the world, we have got to stick with the fuel economy. So, I mean, it was a heady period to a certain extent, and for, like, 5 or 6 years, the industry ran over 17 million. I think, as Alan suggested, for me, a more likely trend volume, if we weren't in a massive credit crisis, and it is probably a million and a half, two million less anyway, rather than if we were normal conditions today we would probably be running more like, I would guess, 15-and-a-half or 16 million units than 17-and-a-half or 18 million units. And it could actually be lower, and the other lesson we have learned is we are planning our business on a much lower volume than that, and if we have to stretch on the up-side, that is a more fun thing to do, anyway. " FOMC20071031meeting--77 75,MR. KOHN.," Thank you, Mr. Chairman. In broad outline, the situation is evolving as we anticipated in our last meeting. Spending outside of housing has been well maintained. The housing market is very weak. Financial markets have been returning more toward normal functioning, banks have tightened credit terms and standards, and core inflation has remained low. I think it is the nuances around each of these that complicate our decision at this meeting. As Dave Stockton and others pointed out, spending outside housing has been a bit stronger than expected. Paths of consumption and investment, along with employment, seem to be moderating going into the fourth quarter, but gradually. Importantly, the data for September haven’t been especially weak, and these could have potentially been affected by the financial tightening, increased uncertainty, and reduced consumer confidence that followed the events of August. With growth in the third quarter likely to be at or above 3 percent and no material change in the output gap for several quarters now, it does appear that the real funds rate of 3 percent plus that persisted since mid-2006, while quite high relative to historical averages, was not far from the equilibrium real rate at that time, given the low level of long-term rates, the ready availability of credit at historically low spreads, and the high level of wealth relative to income through this period. It seems somewhere between difficult and impossible to calibrate the effects on aggregate demand of the rise in long-term rates last spring, the tightening of credit conditions of the past few months, and the expected decline in housing prices. The staff has judged 50 basis points of easing—we did that at the last meeting—to be enough to keep the economy near its potential in the context of the relatively solid incoming data. That doesn’t seem unreasonable, though it does leave the fed funds rate at the higher end of its historical range. Nonetheless, I see a couple of reasons for important downside risks to such a growth forecast. First, though the housing market was roughly in line with staff forecasts, builders have made only a little progress in reducing inventory overhangs. Moreover, reports suggest that downward price pressures are increasing—for example, the constant quality new home index declined in the past two quarters. Market expectations for the Case-Shiller index revised down, suggesting that the drop in house prices could be steeper than the moderate drop assumed in the staff forecast. Substantial decreases in house prices would at some point revive the demand for housing. At the same time, that decline threatens greater spillovers from wealth effects on consumption and from tighter credit conditions as lenders react to threats to their capital from declining collateral values. Second, although financial markets are improving in many respects, the trajectory is gradual, uneven, and subject to reversal. We saw this just in the past couple of weeks, when adverse housing data, downgrades of highly rated mortgages and senior tranches, and earnings warnings caused some risk spreads to widen out. The secondary markets for nonconforming mortgages are still quite disrupted. Clearly, uncertainty about the pricing of many of the assets in question, about the amount of credit that will get put back to the bank balance sheets, and about the size and location of the losses that have to be taken continue to make lenders very skittish. In this environment, I wouldn’t be at all surprised to see a further tightening of credit availability at banks in the coming months. The developments in housing and financial markets are also likely to weigh on business spending plans, as we saw hinted at in the capital spending revisions that some of the Reserve Banks reported, and for households as evidenced by the low confidence surveys. These downside risks are strong enough that I think they will persist even if we ease slightly tomorrow. Besides the influences I already cited, my judgment in this regard takes account of market expectations. The markets’ implied r* has been below the staff’s and, I think, the Committee’s implied r* for some time now, but the gap seems to have widened considerably. In an environment of increased uncertainty about the outlook, such disparities perhaps aren’t surprising, and we can’t substitute market participants’ judgment for our own, but I did take a little signal from the extent of the pessimism about aggregate demand that I inferred from the interest rate path in the market relative to the staff’s path in the Greenbook. I don’t think r* is quite as low as President Yellen was suggesting—it is perhaps in the 2 to 2½ range since term premiums are still low; and even with house prices declining, the wealth-to-income ratios are still pretty high, and the dollar has been falling. But I did assume a slight easing of monetary policy sometime in the fourth quarter in my projection. I also projected low, stable core and ultimately total inflation, but I do see some upside risks around this outcome if the economy follows its most likely path. It is still producing at a high level of resource utilization, and some measures of compensation and labor costs have been rising. Core CPI inflation on three-month and six-month bases has accelerated even if the acceleration hasn’t shown through to the PCE measures. Increases in energy and commodity prices, along with recent declines of the dollar, are also a risk factor—less from their direct effects on prices, which are likely to be small, but more because they could suggest a potential for a more inflationary psychology that could feed through to expectations. Our decision tomorrow will involve weighing these risks, the extent of the relative risk to our dual objectives, and the potential costs of missing in either direction in the context of the market conditions and expectations built into markets. Thank you, Mr. Chairman." CHRG-110shrg50410--55 Mr. Bernanke," Well, I was going to just say that if the investment is made, just like any investor there would be terms and conditions. And if management changes or part of what the assessment was at that point in time, then that would certainly be something that the Treasury Secretary would be able to bring to the table as a possible condition. Senator Hagel. Mr. Chairman. " CHRG-111hhrg54869--113 Mr. Volcker," Well, I am not sure how helpful I can be. I think there is a problem. Obviously you are seeing a lot of failing of small banks, and they are kind of easy to take care of in terms of the capacity of the FDIC, and disturbance or lack thereof, and the failure of a particular small bank. But I do think that it takes judgment. But in a particular case of a small bank, to what extent is the problem one of accounting practice maybe, and I think bank accounting needs some review. I am not sure how important that is to these smaller banks. Are their cases where--bad word, but I will use it--that forbearance would have been justified, and the benefit of the doubt in some sense given to the small bank to see whether it can hold together for a while without forcing it into either a merger or liquidation? I don't know. That takes a very sophisticated and understanding regulatory regime, which may be beyond us. " FOMC20071211meeting--111 109,MR. KOHN.," Thank you, Mr. Chairman. The outlook for economic activity has weakened over the intermeeting period. The housing bust looks steeper with importantly greater declines in prices, and that will affect future consumption. Weakness in housing and the uncovering of greater losses at key financial intermediaries have contributed to a notable deterioration in financial markets and a tightening of some financial conditions. We are also beginning to see signs that economic weakness has not been confined to the housing-related sectors. With regard to activity outside of housing, like many others who have spoken today, I see the most notable development as the flattening-out of consumption spending in September and October. That could reflect the rise in energy prices, but it seems to me that the very deep dip in consumer sentiment suggests that more is at work—that the actual and expected effects of financial market turmoil, for example, on the cost and availability of credit to households along with lower house and stock prices might also be contributing to less-ebullient consumption spending in the recent past and going forward. Capital spending also seems to be slowing. Although business investment spending hasn’t been revised down in the fourth quarter in the Greenbook, logically slower consumption growth will show through before long, as it does beginning in the first quarter in the Greenbook. In addition, we have some more evidence of greater business caution, which could damp business investment relative to expected activity. The NFIB survey for November, for example, shows that the outlook by small businesses deteriorated decidedly in November. There’s a sharp downturn in almost all the outlook indexes for small businesses in this November survey; and as I listen to the reports from around the table, I think for all except a swath of states from Nebraska through Texas, maybe the lower Midwest, I’m hearing a little more pessimism from other places around the country consistent with this. To be sure, employment continues to expand. Various purchasing manager surveys also suggest that activity continues to increase, albeit slowly. But I agree with the staff that, on balance, the incoming data suggest more near-term weakness than anticipated at our last meeting, including some tentative evidence of spillovers from housing. Financial market conditions have deteriorated substantially, and that will place further restraint on growth next year. I think what we learned in the first few weeks of November was that losses are much larger than had been previously anticipated. Those losses stretched into what had been seen as higher quality mortgage-related assets, as Bill Dudley showed us, and the losses are large enough to call into question the ability of some very essential intermediaries to provide support for markets or to extend much additional credit. Those intermediaries include Fannie and Freddie and the financial guarantors, as well as some investment and commercial banks. As concerns about downgrades and potential fire sales rose, investors and institutions moved to protect themselves, with the rise in term funding spreads symptomatic of the greater level of concern. It is logical and reasonable that the response of intermediaries to this concern would be to tighten terms and conditions for their loans to exert greater control over their balance sheets. Expectations that intermediaries will be tightening credit, along with the incoming spending data, led to a more pessimistic view of the economic outlook, and although Treasury rates fell substantially, concern about the performance of borrowers meant that those declines did not show through very much into the cost of funds to private lenders and borrowers. Indeed, a number of indicators point to a net tightening of credit conditions across a range of borrowing sources over the intermeeting period, and that tightening will persist past the New Year. That tightening will have adverse implications for demand by households and businesses in 2008—that is, I do think there’s going to be some spillover from Wall Street to Main Street. Forward measures of the LIBOR-OIS spread for after the year-end moved substantially higher. In effect, the cost to banks of funding will not reflect the full extent of the easing we’ve done in the federal funds market. The spreads on corporate bonds have widened sufficiently to actually increase borrowing costs for both investment- grade and junk-bond issuers over the intermeeting period. The leveraged-loan market deteriorated in late November, forcing banks to take more loans onto their balance sheets, using up scarce balance sheet room. Secondary markets for nonconforming mortgages remain moribund, with no signs of life, and any loans that will be made in these nonconforming sectors will be placed onto the balance sheets of thrifts and banks, many of which are already facing strains. Perhaps as a consequence, rates on prime jumbo mortgages have actually risen over the intermeeting period; Fannie and Freddie have increased fees and are tightening standards, and they face slightly higher spreads. So the damping effect of lower Treasury rates on the cost of conforming housing credit will be held down. All that said, I do see some encouraging signs that the preconditions for future improvements are coming into place. As others have noted specifically, institutions are recognizing and dealing more directly with the implications of these losses. They are recognizing the losses more aggressively. They’re raising capital, and they’re being more explicit about taking contingent liabilities like SIVs onto their balance sheets. Even so, I think that what we have learned over the intermeeting period is that the process of returning financial markets to more normal functioning is going to take longer and the disruption to the cost and availability of credit will be greater than I had thought just six weeks ago. Prospects for a period of weaker economic growth and reduced resource utilization do work to lower inflation risks. In addition, we’ve seen a downward revision to compensation and unit labor costs, and commodity prices outside food and energy have fallen substantially in recent weeks. At the same time, energy prices have risen, and past inflation data have been revised higher, and the staff has actually revised up its inflation forecast by a tenth or two over the next few years. So on balance, I judge the inflation risk still to be to the upside if the economy follows the modal forecast but by considerably less than I thought at the last meeting. I look forward to a discussion in the next part of the meeting about how we deal with the policy implications of this changing situation." CHRG-111hhrg58044--344 Mr. Pratt," Thank you. A couple of things. First of all, credit scores are not used--I just want to make that clear--I understand the credit history is used, but not credit scores. So that's an irrelevant discussion. Credit scores are not used in employment. An employer wants to know, when they look at a credit report, what caused the problem in the credit report. Employers are smart, and they want to hire good people. That's why they use resumes, and that's why they use other types of tests of your qualifications. And that's why a credit report is not a single determining factor in whether or not you get the job. And if you show some financial distress over the last couple of years, employers are smart enough, because it's a credit history, which shows the full history of your hard work. It shows, by that band of difficulty is correlating very closely with the circumstances we have had in this country, with unemployment. So, an employer is not going to simply flip that application aside, particularly when they have a qualified person. The other very important point--and I keep coming back to this--is credit reports are not being used across the whole spectrum for every kind of job. If you're stocking a shelf, a credit report is probably not being used. If you're entering the construction trades, a credit report is probably not being used. It's being used, based on the surveys from the Society for Human Resources Management, as you would expect, if you are a CFO, and you have fiduciary responsibilities, if you have access to cash, a small business owner may want to know that. And, by the way, small business owners are some of the ones who do want to use a credit history as part of the review process. But that's why they have interviews, Mr. Hensarling. They have interviews to learn more about why you are qualified for the job, and why you should be the one hired for the job. " CHRG-111hhrg52407--7 Mr. Marchant," Thank you, Mr. Chairman. After reviewing last night all of the testimony that we will be given today, I am struck that all of your testimony seems to be directed towards a system that I think Mr. Hensarling has already pointed out is most likely not to be in place this time next year. In fact, with the current--the legislation that we just passed in the last few months, two pieces of legislation about credit cards, and the President has signed one of those pieces of legislation, significantly limiting the terms and conditions of credit cards and simplifying the credit card system; and taking into consideration that probably 80 percent of all home loans are made now through either FHA, VA, Fannie Mae, or Freddie Mac, and all of those documents are promulgated through HUD and through government agencies already; it seems to me that your task in the future may be trying to figure out how you can work with those Federal agencies, this new Financial Consumer Protection Agency, how you can work with them to try to help them promulgate all of these loan forms and all of the loan documents that each and every banker and lender in America will most likely have to go and get their loan papers approved and everything they do, and make sure that promulgation of documents is done through that agency. So it may simplify your job if you can, if you think you can trust this new financial consumer agency to draft the documents to where everyone who reads them will have no problem. So I think my questions today, Mr. Chairman, are going to be directed in that direction, and ask you what your opinion is of that agency and how you plan on interfacing with that agency. Thank you. " FOMC20081029meeting--211 209,MR. LACKER.," Thank you, Mr. Chairman. Business and consumer sentiment in the Fifth District has deteriorated markedly. Even though economic conditions were already decelerating heading into our September meeting, a discrete shift in outlook seems to have occurred. It seems to me to have originated during the week of September 15 or shortly thereafter. Our business contacts express anxiety about the national economy, and they express uncertainty about the meaning for their firms' prospects of the astonishing sequence of events that began unfolding that week. Both consumers and firms have been increasingly unwilling to make long-term commitments and engage in discretionary expenditures. Consumers are delaying large and discretionary expenditures. Firms have adopted a wait-and-see attitude on investments. Our regional survey released this morning shows a substantial drop in business conditions as well. Our business survey respondents report that obtaining business loans is more difficult than three months ago, and there are widespread reports of lenders tightening credit terms and seeking to reduce exposures. Most respondents, however, also indicated that they would still be able to satisfy their borrowing needs. When you listen to bankers, they will tell you that they are tightening standards, but they also report that they are still extending credit to solid borrowers with high-quality deals. I find it difficult right now to pin down the real effects of the financial market turmoil of the last few weeks. As the Greenbook notes, assessing such effects ""poses significant identification challenges."" Specifically, it is hard to disentangle the effects of the increased cost of bank capital from those of the deterioration in the economic environment facing borrowers. Personally, I suspect the latter are playing the more prominent role in the tightening of credit terms right now. Looking on the bright side, the near-term inflation picture has eased noticeably since our September meeting, mainly because of the decline in oil and other commodity prices. The Greenbook carries this moderation into its long-term forecast, where PCE inflation now converges to 1 percent in 2013. I did a double-take when I saw that--it had me wondering whether the Greenbook was ghost-written this month by President Plosser. [Laughter] Whoever's forecast it is, the longer-term projected moderation in inflation relies heavily on the opening-up of a large and persistent output gap. In the current circumstances, I am not sure how plausible that story is. In particular, I have been struggling with how to think about the effect of credit market disruptions on the concept of potential output. To the extent that we think of these disruptions as analogous to shocks to intermediation technology--and that is what the models of these kinds of credit channel effects generally tell you to do--it seems to me that we should see them as pulling down potential as well as actual output. I believe this point has been made at previous meetings. We have also talked before about the tenuous nature of the Phillips curve relationship, and it is difficult to forecast. The slope is sort of flat. We had been scheduled to discuss inflation dynamics, and we postponed that, for good reasons I believe. I hope we can get back to it soon because I think it's going to be relevant to how we see our way through this. In any event, I think we should be careful not to be overly optimistic about the forecast of an inflation decline driven by a large output gap. The shift in the Greenbook's long-term inflation projection is noteworthy for another reason, I believe. We are getting closer to a 1 percent target federal funds rate, and we may actually reach 1 percent at some meeting soon. The last time this happened it sparked a widespread discussion of and concern about the zero lower bound on nominal interest rates. I want to make a couple of related observations. First, a key to conducting monetary policy at the zero bound is being able to keep inflation expectations from falling and thereby increasing real interest rates. From this perspective, the revision of the Greenbook's forecast from 1.7 percent one meeting ago to 1.0 percent for five-year-ahead inflation implies that we run a monetary policy regime in which five-year-ahead expected inflation varies pretty significantly in response to contemporaneous shocks. I don't think that variability in long-run inflation projections can help our ability to manage inflation expectations at the zero bound. We'd be better if we ran a policy in which long-run expected inflation was more anchored, more stable. You can tell where I'm going with this, I'm sure. This highlights the value of an explicit inflation objective as well as the value of being able to communicate clearly about how we view the functioning of monetary policy at the zero bound. Second, I will just note briefly that the economics of monetary policy at the zero bound are closely related to the economics of paying interest on reserves at close to the target rate. In fact, if I'm not mistaken, they are virtually identical. I think progress on both fronts would be useful right now. Finally, let me just comment on financial market conditions. My sense is that what the public has seen--the large failures, the variety of resolution techniques, the deliberations leading up to the Congress's adoption of the bill it adopted--taken together have added up to significant pessimism on people's parts and have altered optimal strategy for a lot of financial institutions. So I think that is altering how people allocate portfolios and has led to further volatility in certain markets. It has led some institutions to adopt a wait-and-see attitude, to see how particular programs are going to be implemented. I think that we are seeing at least some dead-weight loss associated with the burdens of shifting financial flows between things that are covered and things that aren't and we are seeing a good deal of rent-seeking behavior as well. What we are seeing is going to have the effect of masking the evolution of underlying fundamentals. It is going to make it harder to see our way through this and understand just what is happening. I think that is going to be a thicket that we will need to cut through in the months ahead. That concludes my comments, Mr. Chairman. " CHRG-110hhrg44901--11 Mr. Bernanke," Thank you, Chairman Frank, Ranking Member Bachus, and members of the committee. I am pleased to present the Federal Reserve's Monetary Report to the Congress. The U.S. economy and financial system have confronted some significant challenges thus far in 2008. The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions. The effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the price of energy and other commodities, which have zapped household purchasing power even as they have boosted inflation. Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year, while inflation has remained elevated. Following a significant reduction in its policy rate over the second half of 2007, the Federal Open Market Committee eased policy considerably further through the spring to counter actual and expected weakness in economic growth and to mitigate downside risks to economic activity. In addition, the Federal Reserve expanded some of the special liquidity programs that were established last year and implemented additional facilities to support the functioning of financial markets and foster financial stability. Although these policy actions have had positive effects, the economy continues to face numerous difficulties, including ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of oil, food, and some other commodities. Let me now turn to a more detailed discussion of some of these issues. Developments in financial markets and their implications to the macroeconomic outlook have been a focus of monetary policymakers over the past year. In the second half of 2007, the deteriorating performance of subprime mortgages in the United States triggered turbulence in domestic and international financial markets as investors became markedly less willing to bear credit risk of any type. In the first quarter of 2008, reports of further losses and write-downs in financial institutions intensified investor concerns and resulted in further sharp reductions in market liquidity. By March, many dealers and other institutions, even those that had relied heavily on short-term secured financing, were facing much more stringent borrowing conditions. In mid-March, a major investment bank, The Bear Stearns Companies, Inc., was pushed to the brink of failure after suddenly losing access to short-term financing markets. The Federal Reserve judged that a disorderly failure of Bear Stearns would pose a serious threat to overall financial stability and would most likely have significant adverse implications for the U.S. economy. After discussions with the Securities and Exchange Commission, and in consultation with the Treasury, we invoked emergency authorities to provide special financing to facilitate the acquisition of Bear Stearns by JPMorgan Chase & Company. In addition, the Federal Reserve used emergency authorities to establish two new facilities to provide backstop liquidity to primary dealers, with the goals of stabilizing financial conditions and increasing the availability of credit to the broader economy. We have also taken additional steps to address liquidity pressures in the banking system, including a further easing of the terms for bank borrowing at the discount window and increases in the amount of credit made available to banks through the Term Auction Facility. The FOMC also authorized expansion of its currency swap arrangements with the European Central Bank and the Swiss National Bank to facilitate increased dollar lending by those institutions to banks in their jurisdictions. These steps to address liquidity pressures, coupled with monetary easing, seem to have been helpful in mitigating some market strains. During the second quarter, credit spreads generally narrowed, liquidity pressures ebbed, and a number of new financial institutions raised new capital. However, as events in recent weeks have demonstrated, many financial markets and institutions remain under considerable stress in part because of the outlook for the economy and thus for credit quality, which remains uncertain. In recent days, investors became particularly concerned about the financial condition of the Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac. In view of this development, and given the importance of these firms to the mortgage market, the Treasury announced a legislative proposal to bolster their capital, access to liquidity, and regulatory oversight. As a supplemental to the Treasury's existing authority to lend to the GSEs, and as a bridge to the time when Congress decides how to proceed on these matters, the Board of Governors authorized the Federal Reserve Bank of New York to lend to Fannie Mae and Freddie Mac, should that become necessary. Any lending would be collateralized by U.S. Government and Federal agency securities. In general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve. I turn now to current economic developments and prospects. The economy has continued to expand, but at a subdued pace. In the labor market, private payroll employment has declined, falling at an average pace of 94,000 jobs per month through June. Employment in the construction and manufacturing sectors has been particularly hard hit, although employment declines in a number of other sectors are evident as well. The unemployment rate has risen and now stands at 5\1/2\ percent. In the housing sector, activity continues to weaken. Although sales of existing homes have been about unchanged this year, sales of new homes have continued to fall, and inventories of unsold new homes remain high. In response, homebuilders continue to scale back the pace of housing starts. Home prices are falling, particularly in regions that experienced the largest price increases earlier this decade. The declines in home prices have contributed to the rising tide of foreclosures. By adding to the stock of vacant homes for sale, these foreclosures have in turn intensified the downward pressure on home prices in some areas. Personal consumption expenditures have advanced at a modest pace so far this year, generally holding up somewhat better than might have been expected, given the array of forces weighing on households and attitudes. In particular, with the labor market softening and consumer price inflation elevated, real earnings have been stagnant so far this year. Declining values in equities have taken their toll on household balance sheets, credit conditions have tightened, and indicators of consumer sentiment have fallen sharply. More positively, the fiscal stimulus package is providing some timely support to household incomes. Overall, consumption spending seems to be constrained over coming quarters. In the business sector, real outlays for equipment and software were about flat in the first quarter of the year, and construction of nonresidential structures slowed appreciably. In the second quarter, the available data suggests that business fixed investment appears to have expanded moderately. Nevertheless, surveys of capital spending plans indicate that firms remain concerned about the economic and financial environment, including sharply rising cost of inputs and indications of tightening credit, and they are likely to be cautious with spending in the second half of this year. However, strong export growth continues to be a significant boon to many U.S. companies. In conjunction with the June FOMC meeting, Board Members and Reserve Bank Presidents prepared economic projections covering the years 2008 through 2010. On balance, most FOMC participants expected that over the remainder of this year, output would expand at a pace appreciably below its trend rate, primarily because of continued weakness in housing markets, elevated energy prices, and tight credit conditions. Growth is projected to pick up gradually over the next 2 years as residential construction bottoms out and begins a slow recovery, and as credit conditions gradually improve. However, FOMC participants indicated that considerable uncertainty surrounded their outlook for economic growth and viewed the risks to their forecasts as skewed to the downside. Inflation has remained high, running at nearly a 3\1/2\ percent annual rate over the first 5 months of this year as measured by the price index for personal consumption expenditures. And with gasoline and other consumer energy prices rising in recent weeks, inflation seems likely to move temporarily higher in the near term. The elevated level of overall consumer inflation largely reflects a continued sharp run-up in the prices of many commodities, especially oil, but also certain crops and metals. The spot price of West Texas intermediate crude oil soared about 60 percent in 2007, and thus far this year has climbed an additional 50 percent or so. The price of oil currently stands at about 5 times its level toward the beginning of this decade. Our best judgment is that the surge has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets. Over the past several years, the world economy has expanded its fastest pace in decades, leading to substantial increases in the demand for oil. Moreover, growth has been concentrated in developing and emerging market economies, where energy consumption has been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users. On the supply side, despite sharp increases in prices, the production of oil has risen only slightly in the past few years. Much of the subdued supply response reflects inadequate investment and production shortfalls in politically volatile regions where large portions of the oil reserves are located. Additionally, many governments have been tightening their control over oil resources, impeding foreign investment and hindering efforts to boost capacity and production. Finally, sustainable rates of production in some of the more accessible oil fields, such as those in the North Sea, have been declining. In view of these factors, estimates of long-term oil supplies have been marked down in recent months. Long-dated oil futures prices have risen, along with spot prices, suggesting that market participants also see oil supply conditions remaining tight for years to come. The decline in the foreign exchange value of the dollar has also contributed somewhat to the increase in oil prices. The precise size of this effect is difficult to ascertain, as the causal relationships between oil prices and the dollar are complex and run in both directions. However, the price of oil has risen significantly in terms of all major currencies, suggesting that factors other than the dollar, notably shifts in the underlying global demand for and the supply of oil, have been the principal drivers of the increase in prices. Another concern that has been raised is that financial speculation has added markedly to upward pressures on oil prices. Certainly, investor interest in oil and other commodities has increased substantially of late. However, if financial speculation were pushing above the levels consistent with the fundamentals of supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell. But, in fact, available data on oil inventories show notable declines over the past year. This is not to say that useful steps could not be taken to improve the transparency and functioning of futures markets, only that such steps are unlikely to substantially affect the prices of oil or other commodities in the longer term. Although the inflationary effect of rising oil and agricultural commodity prices is evident in the retail prices of energy and food, the extent to which the high prices of oil and other raw materials have been passed through to the prices of nonenergy, nonfood finished goods and services seems thus far to have been limited. But with businesses facing persistently higher input prices, they may attempt to pass through such costs into final goods and services more aggressively than they have so far. Moreover, as the foreign exchange value of the dollar has declined, rises in import prices have been greater upward pressure on business costs and consumer prices. In their economic projections for the June FOMC meeting, monetary policymakers marked-up their forecast for inflation during 2008 as a whole. FOMC participants continue to expect inflation to moderate in 2009 and 2010, as slower global growth leads to a cooling of commodity markets, as pressures on resource utilization decline, and as longer-term inflation expectations remain reasonably well-anchored. However, in light of the persistent escalation of commodity prices in recent quarters, FOMC participants viewed the inflation outlook as unusually uncertain and cited the possibility that commodity prices will continue to rise as an important risk to the inflation forecast. Moreover, the currently high levels of inflation, if sustained, might lead the public to revise up its expectations for longer-term inflation. If that were to occur, and those revised expectations were to become embedded in the domestic wage and price-setting process, we would see an unwelcome rise in actual inflation over the longer term. A critical responsibility of monetary policymakers is to prevent that process from taking hold. At present, accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policymakers. The possibility of higher energy prices, tighter credit conditions, and a still deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately as the rising prices of energy and some other commodities have led to a sharp pickup in inflation, and some measures of inflation expectations have moved higher. Given the high degree of uncertainty, monetary policymakers will need to carefully assess incoming information bearing on the outlook for both inflation and growth. In light of the increase in upside inflation risk, we must be particularly alert to any indications, such as an erosion of longer-term expectations, that the inflationary impulses are becoming embedded in the domestic wage and price-setting process. I would like to conclude my remarks by providing a brief update on some of the Federal Reserve's actions in the area of consumer protection. At the time of our report last February, I described the Board's proposal to adopt comprehensive new regulations to prohibit unfair or deceptive practices in the mortgage market, using our authority under the Home Ownership and Equity Protection Act of 1994. After reviewing the more than 4,500 comment letters we received under the proposed rules, the Board approved the final rules on Monday. The new rules apply to all types of mortgage lenders and will establish lending standards aimed at curbing abuses, while preserving subprime lending and sustainable homeownership. The final rules prohibit lenders from making higher-priced loans without due regard for consumers' ability to make the scheduled payments, and require lenders to verify the income and assets on which they rely when making the credit decision. Also, for higher-priced loans lenders now will be required to establish escrow accounts so that property taxes and insurance costs will be included in consumers' regularly monthly payments. The final rules also prohibit prepayment penalty for higher-priced loans in cases in which the consumer's payment can increase during the first few years and restrict prepayment penalties or other higher-priced loans. Other measures address coercion of appraisers, servicer practices, and other issues. We believe the new rules will help to restore confidence in the mortgage market. In May, working jointly with the Office of Thrift Supervision and the National Credit Union Administration, the Board issued proposed rules under the Federal Trade Commission Act to address unfair or deceptive practices for credit card accounts and overdraft protection plans. Credit cards provide a convenient source of credit for many consumers, but the terms of credit cards loans have become more complex, which has reduced transparency. Our consumer testing has persuaded us that disclosures alone cannot solve this problem. Thus, the Board's proposed rules would require card issuers to alter their practices in ways that will allow consumers to better understand how their own decisions and actions will affect their costs. Card issuers will be prohibited from increasing interest rates retroactively to cover prior purchases except under very limited circumstances. For accounts having multiple interest rates, when consumers seek to pay down their balance by paying more than the minimum, card issuers will be prohibited from maximizing interest charges by applying excess payments to the lowest rate balance first. The proposed rules dealing with bank overdraft services seek to give consumers greater control by ensuring that they have ample opportunity to opt out of automatic payments of overdrafts. The Board has already received more than 20,000 comment letters in response to these proposed rules. Thank you. I have would be very pleased to take your questions. " FOMC20071211meeting--102 100,MR. PLOSSER.," Thank you, Mr. Chairman. There has been little change in the economic conditions in our District since the October meeting. Except for housing activity, manufacturing and other businesses are expanding at a modest pace, somewhat below trend. Our business contacts are a little less optimistic about growth in the near term than they were earlier in the fall primarily because of uncertainty surrounding the outlook rather than any immediate change in their business activity. I’ll begin by reporting on what our contacts say about credit conditions. Business contacts as well as our board of directors have told me that credit activity has changed very little. Creditworthy borrowers, as far as they were concerned, have had no problem accessing credit. Banks have reported some tightening of lending standards, but mostly that has occurred for real estate developers and in residential mortgages. Some loan demand has dropped because of businesses’ uncertainty about the future, as I suggested earlier. That is, businesses seem to be a bit more cautious. But banks do not appear to be conserving capital. In fact, they’re actively seeking good credits. To quote one of my directors, “The crunch on Wall Street has not hit Main Street.” A couple of bankers I spoke to, one representing a very large regional bank and another a very large community bank, expressed the view that they were actively seeking to regain market share from the larger banks because they did not engage in the same off-balance-sheet financing of riskier debt that the large banks did and so they were not facing either capital or funding constraints. Some bankers acknowledge that consumer credit quality seems to have deteriorated slightly, but they reminded me that this was from very good levels. So the defaults and delinquencies remain well within historical norms. Turning to the economy, payroll employment continues to expand at a somewhat slow pace in our three states, yet the unemployment rate is still 0.4 percentage point below that of the nation. Retail sales picked up in November. Moreover, retailers generally said they met their expectations for the Thanksgiving weekend. However, these sales seem to have been boosted by fairly heavy discounting, according to them; and despite the reasonable showing to date, retailers are wary and uncertain for the holiday season. Housing construction and sales continue to decline, but the pace of that decline is in line with the expectations at the time of our last meeting. Nonresidential real estate markets remain firm in our District. Office vacancy rates continue to decline, and commercial rents are rising. New contracts for commercial real estate have declined, however; but with the decline in vacancy rates and with rising rents, the outlook of many developers is not as negative as the current level of spending would suggest. According to our Business Outlook Survey, manufacturing activity in the District has been increasing at a modest pace for the past few months. The index of general activity moved up slightly, to 8.2 in November from 6.8 in October. This is actually about the same average level that the outlook survey has maintained over the past two years. Shipments and new orders moved up slightly. However, optimism regarding the outlook over the next six months declined. It’s a common theme of many of our business contacts that their businesses have not changed much, but they seem to be reacting to the steady stream of negative news, and it is affecting their outlook. Indeed, the CEOs of several very large industrial firms in our District report business to be very strong both domestically and overseas, and the CEOs have seen little effect of the turmoil on Wall Street on their ability to obtain credit. Now, last time I said that there had been little change in the District’s inflation picture. However, we have started to see evidence of increased price pressures. The Business Outlook Survey’s prices-paid index has risen considerably since the beginning of the year and has doubled since August. The index for prices received has also more than doubled since August, rising sharply in both October and November. Also retailers have noted spreading price increases for imported goods, and a wide range of industries are reporting increases in energy and transportation costs. Firms continue to report higher health care costs, and at the same time, wages continue to be moderate, they say. In summary, economic conditions have changed little since our last meeting. The business activity in the region is advancing at a moderate pace. Credit constraints experienced by the large money center banks have not appreciably affected the banks in our District or their lending practices. In general, firms in the District remain cautiously optimistic about their businesses six months from now but not so much as they were last month. Price pressures have increased on the input side related to energy and commodity costs; more generally, many firms are now prepared to raise their own prices and are looking to do so in the near future, and the financial conditions of our banks remain good. Turning to the nation, financial market conditions, especially those associated with the big money center banks, have clearly deteriorated in recent weeks. Until the end of October, spreads were gradually declining. It seems that the potential for a serious meltdown was monotonically declining. However, since early November, as we all pointed to, a number of financial institutions, subprime mortgages, jumbo mortgages, asset-backed commercial paper, below-investment-grade bonds, and LIBOR have experienced increased spreads. Volatility has risen as well. Clearly, risk premiums have risen for certain classes of assets, and investors have fresh concerns about the way credit market conditions are evolving. Overall, the recent financial developments suggest that it will take longer before conditions are “back to normal” in all segments of the market. As I’ve said before, I continue to believe that price discovery still plagues many of these markets. It now looks as though it will take a little longer before these markets can sort things out and return to normal. Financial institutions continue to write off some of the investments and take losses. I view these write-downs as a necessary and healthy part of the process toward stabilization. Infusions of capital in some financial institutions, I think, are encouraging and helpful to the process. This does not mean that the ultimate agreed-upon market prices for some of these assets will bear any resemblance to what they did before August. Indeed, they probably won’t. But that’s not necessarily a bad sign, nor is it a cause for concern. In general, it may be a very healthy development. The news on economic activity has softened somewhat since our last meeting. Among the negatives, of course, the housing market and residential investment continue to decline. Foreclosures have continued to grow at unprecedented rates. Firms have become a little more cautious in their investment plans. Consumer spending has softened slightly, and real disposable personal income declined in October. Oil prices have moved higher. On the brighter side so far, there is some evidence of spillovers from the financial and housing markets to the broader economy, but I believe it is limited. Net exports and business fixed investment have been surprises on the upside. Finally, and most important, the labor market still looks pretty solid. Foreclosures and consumer weaknesses appear to be heavily concentrated in those states where the housing boom and thus the housing price declines have been most pronounced—especially California, Nevada, and Florida—and in those states, such as Ohio and Michigan, that are feeling the effects of the decline in automobile manufacturing. As President Poole indicated, credit card delinquencies were up but highly concentrated in California, Nevada, and Florida. Thus, based on such observations and the news that I hear from my District, I sense that the stresses in the economy vary significantly by region, and we must be mindful that the weaknesses on Wall Street are in those states that have exaggerated housing volatility and may not be representative of the rest of the economy. To be sure, we must be wary of continued deterioration and spillovers, but at this point my assessment is that they remain concentrated in a few regions and are not as widespread as some of the aggregate data might suggest. It’s important to note that, for a good part of the forecast for the fourth-quarter GDP, it’s payback for strong inventories and net export numbers in the third quarter. I note that, absent payback and despite the worsening news, economic growth would be on the order of 2 percent higher. To put this differently, the news since the last meeting has not altered the overall GDP forecast for the second half of 2007. It’s about the same. The news has clearly altered the Greenbook’s forecast for 2008, especially for the first half of the year but also extending into the second half of 2008. The forecast calls for explicit spillovers from financial markets and the housing sector to the broader economy, to consumption, to fixed investment, and so forth. I should note, however, that most private sector forecasters are significantly less pessimistic than the Greenbook. The Blue Chip survey, our just-released Livingston Survey, our Survey of Professional Forecasters, and several of the major forecasting firms that have issued forecasts in the last couple of weeks see weakness extending into the first and maybe the second quarter of 2008 but a much more rapid bounceback in the second half of 2008 than is suggested in the Greenbook. These private sector forecasts are more in line with my own view. While the news on growth is somewhat on the downside, the news on inflation is on the upside. Readings on core inflation have been stable over the last few months, but headline inflation rates have risen sharply, with increases in energy and commodity prices. The broader scope of these commodity price increases and their breadth suggest that perhaps there are more-generalized inflationary pressures out there rather than these isolated relative price shocks. I will note that the core PCE inflation rate for March to June was 1½ percent; and in every three-month window subsequently, the inflation rate has risen monotonically, now reaching 2.26 percent for the latest three-month period from August to October. This comes after fairly steady declines in core rates during the first half of the year. In my comments on the Third District, I noted the greater prospects for price increases indicated by our manufacturing firms. I also am going to cite another statistic from the same survey that President Evans referred to—Duke University’s CFO Magazine survey. The survey to which he referred was a survey conducted in late November and early December of more than 600 CFOs. In the survey, the average price increase that these CFOs were estimating for their own products in the coming year was 2.8 percent, and that was up from just 2 percent in the previous quarter. Thus, it appears that firms are beginning to be more interested in increasing prices and are more able to do so than they were just a few months ago, even though the same CFOs were more pessimistic about the economy than they were in the last quarter. Another piece of news on inflation expectations comes from the Livingston Survey, which was just released yesterday. There the forecast of the average annual change for the CPI for 2007 to 2008 moved up from 2.3 percent to 3 percent. This, of course, partially reflects the behavior of oil prices during the past several months. The December-to-December forecast, on the other hand, also rose, but only slightly. Thus, overall, the economy is weak but only slightly more so than I anticipated. Volatility in the financial markets continues, and the repricing of risk has not progressed as smoothly as I would like to see. Nevertheless, the spillovers from the financial turmoil seem geographically concentrated, and broader spillovers appear limited to date. I view inflation expectations as fragile and see evidence that price pressures are growing and that more and more firms feel that price increases are coming and are supportable. I think we will have to be very careful not to presume that just because price expectations and prices have remained contained that they will continue to be so, independent of our actions. Thank you." CHRG-111shrg54589--104 Mr. Whalen," Oh, I think most over-the-counter contracts do not have a problem in that regard. If you are talking about energy, currency, whatever it is, if there is a rigorous traded cash market, it is easy to come up with a derivative, even if it is a very complex derivative. But when you are talking about illiquid corporate bonds or even loans to corporations, if you are talking about a complex structured asset that is, let us say, two or three levels of packaging away from the reference asset that it is supposed to be ``derived'' from, that creates complexity in terms of pricing that I think is rather daunting. And I will tell you now, there are very few firms on the street that have the people, the resources, and the money to do that work. Let me give you an example---- Senator Johanns. Mr. Whalen, doesn't that get us to the point that I was raising in previous questioning? You know, you have now got a whole regulatory scheme. You have got somebody that is going to regulate it. They are hired and paid---- " CHRG-111shrg56415--3 Mr. Dugan," Thank you, Chairman Johnson, Senator Crapo, and members of the Subcommittee. I am pleased to testify on the current condition of the national banking system, including trends in bank lending, asset quality, and problem banks. The OCC supervises over 1,600 national banks and Federal branches, which constitute approximately 18 percent of all federally insured banks and thrifts, holding just over 61 percent of all bank and thrift assets. As described in my written statement, the OCC has separate supervisory programs for large, mid-sized, and community banks that are tailored to the unique challenges faced by each. Today I would like to focus on three key points. First, despite early signs of the recession ending, credit quality is continuing to worsen across almost every class of asset in banks of almost every size. The strains on borrowers that first appeared in the housing sector have spread to other retail and commercial borrowers. For some credit portfolio segments, the rate of nonperforming loans is at or near historical highs. In many cases, this declining asset quality reflects risks that have been built up over time. While we are seeing some initial signs of improvement in some asset classes, as the economy begins to recover, it will take time for problem credits to work their way through the banking system because credit losses often lag behind the return to economic growth. Second, it is very important to keep in mind that the vast majority of national banks are strong and have the financial capacity to withstand declining asset quality. As I noted in testimony before the full Committee last year, we anticipated that credit quality would worsen and that banks would need to further strengthen their capital and loan loss reserves. Net capital levels in national banks have increased by more than $186 billion over the last 2 years, and net increases to loan loss reserves have exceeded $92 billion. While these increases have considerably strengthened national banks, we anticipate additional capital and reserves will be needed to absorb additional potential losses in banks' portfolios. In some cases, that may not be possible, however, and as a result, there will continue to be a number of smaller institutions that are not likely to survive their mounting credit problems. In these cases, we are working closely with the FDIC to ensure timely resolutions in a manner that is least disruptive to local communities. Third, during this stressful period, we are extremely mindful of the need to maintain a balanced approach in our supervision of national banks. We strive continually to ensure that our examiners are doing just that. We are encouraging banks to work constructively with borrowers who may be facing difficulties and to make new loans to creditworthy borrowers, although it is true that in today's weaker economic environment, credit demand among businesses and consumers has significantly declined. And we have repeatedly and strongly emphasized that examiners should not dictate loan terms or require banks to charge off loans simply due to declines in collateral values. Balanced supervision, however, does not mean turning a blind eye to credit and market conditions or simply allowing banks to forestall recognizing problems on the hope that markets or borrowers may turn around. As we have learned in our dealings with problem banks, a key factor in restoring a bank to health is ensuring that bank management realistically recognizes and addresses problems as they emerge, even as they work with struggling borrowers. One area where national banks are stepping up efforts to work with distressed borrowers is in foreclosure prevention. Our most recent quarterly report on mortgage metrics shows that actions by national bank servicers to keep Americans in their homes rose by almost 22 percent in the second quarter. Notably, the percentage of modifications that reduced monthly principal and interest payments increased to more than 78 percent of all new modifications, up from about 54 percent the previous quarter. We view this as a positive development since modifications that result in lower monthly payments are less likely to redefault. While many challenges lie ahead, especially with regard to the significant decline in credit quality, I firmly believe that the collective measures that Government officials, bank regulators, and many bankers have taken in recent months have put our financial system on a much more sound footing. The OCC is firmly committed to a balanced approach that encourages bankers to lend and to work with borrowers in a safe and sound manner while recognizing and addressing problems on a timely basis. Thank you. Senator Johnson. Thank you, Mr. Dugan. " Mr. Tarullo," STATEMENT OF DANIEL K. TARULLO, MEMBER, BOARD OF GOVERNORS OF FOMC20070807meeting--120 118,MS. PIANALTO.," Thank you, Mr. Chairman. As I said earlier, I do think that the risks to the outlook for economic growth have increased while the risks to the outlook for inflation have moderated but are still to the upside. So I found the suggestion on page 25 of the Bluebook that we might want to mix and match the alternative A and B language appealing, but I did think that changing our statement in that way could convey a greater shift in our risk assessment than I believe is warranted today. So I think the revised version of alternative B makes the modest but important adjustment of acknowledging the recent change in credit conditions in the rationale section, and it signals the greater downside risks to growth in the risk assessment section. So I support our alternative B—that is, no change in the fed funds rate today and the language that is in the revised version. Thank you." CHRG-110shrg50409--8 Mr. Bernanke," Chairman Dodd, Senator Shelby, and Members of the Committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. The U.S. economy and financial system has confronted some significant challenges thus far in 2008. The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions. The effects of the housing contraction and of the financial head winds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities which have sapped household purchasing power even as they have boosted inflation. Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year while inflation has remained elevated. Following a significant reduction in its policy rate over the second half of 2007, the Federal Open Market Committee eased policy considerably further through the spring to counter actual and expected weakness in economic growth and to mitigate downside risk to economic activity. In addition, the Federal Reserve expanded some of the special liquidity programs that were established last year and implemented additional facilities to support the functioning of financial markets and foster financial stability. Although these policy actions have had positive effects, the economy continues to face numerous difficulties, including ongoing strains on financial markets, declining house prices, a softening labor market, and rising prices of oil, food, and some other commodities. Let me now turn to a more detailed discussion of some of these key issues. Developments in financial markets and their implications to the macroeconomic outlook have been a focus of monetary policymakers over the past year. In the second half of 2007, the deteriorating performance of subprime mortgages in the United States triggered turbulence in domestic and international financial markets as investors became markedly less willing to bear credit risks of any type. In the first quarter of 2008, reports of further losses and writedowns by financial institutions intensified investor concerns and resulted in further sharp reductions in market liquidity. By March, many dealers and other institutions, even those that had relied heavily on short-term secured financing, were facing much more stringent borrowing conditions. In mid-March, a major investment bank, the Bear Stearns Companies Incorporated, was pushed to the brink of failure after suddenly losing access to short-term financing markets. The Federal Reserve judged that a disorderly failure of Bear Stearns would pose a serious threat to overall financial stability and would most likely have significant adverse implications for the U.S. economy. After discussions with the Securities and Exchange Commission and in consultation with the Treasury, we invoked emergency authorities to provide special financing to facilitate the acquisition of Bear Stearns by JPMorgan Chase and Company. In addition, the Federal Reserve used emergency authorities to establish two new facilities to provide backstop liquidity to primary dealers, with the goals of stabilizing financial conditions and increasing the availability of credit to the broader economy. We have also taken additional steps to address liquidity pressures in the banking system, including a further easing of the terms for bank borrowing at the discount window and increases in the amount of credit made available to banks through the Term Auction Facility. The FOMC also authorized expansion of its currency swap arrangements with the European Central Bank and the Swiss National Bank to facilitate increased dollar lending by those institutions to banks in their jurisdictions. These steps to address liquidity pressures, coupled with monetary easing, seem to have been helpful in mitigating some market strains. During the second quarter, credit spreads generally narrowed, liquidity pressures ebbed, and a number of financial institutions raised new capital. However, as events in recent weeks have demonstrated, many financial markets and institutions remain under considerable stress, in part because the outlook for the economy and, thus, for credit quality remains uncertain. In recent days, investors became particularly concerned about the financial condition of the Government-sponsored enterprises Fannie Mae and Freddie Mac. In view of this development, and given the importance of these firms to the mortgage market, the Treasury announced the legislative proposal to bolster their capital, access to liquidity, and regulatory oversight. As a supplement to the Treasury's existing authority to lend to the GSEs, and as a bridge to the time when the Congress decides how to proceed on these matters, the Board of Governors authorized the Federal Reserve Bank of New York to lend to Fannie Mae and Freddie Mac should that become necessary. Any lending would be collateralized by U.S. Government and Federal agency securities. In general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve. I turn now to current economic developments and prospects. The economy has continued to expand, but at a subdued pace. In the labor market, private payroll employment has declined this year, falling at an average pace of 94,000 jobs per month through June. Employment in the construction and manufacturing sectors has been particularly hard hit, although employment declines in a number of other sectors are evident as well. The unemployment rate has risen and now stands at 5.5 percent. In the housing sector, activity continues to weaken. Although sales of existing homes have been unchanged this year, sales of new homes have continued to fall, and inventories of unsold new homes remain high. In response, home builders continue to scale back the pace of housing starts. Home prices are falling, particularly in regions that experienced the largest price increases earlier this decade. The declines in home prices have contributed to the rising tide of foreclosures. By adding to the stock of vacant homes for sale, these foreclosures have in turn intensified the downward pressure on home prices in some areas. Personal consumption expenditures have advanced at a modest pace so far this year, generally holding up somewhat better than might have been expected given the array of forces weighing on household finances and attitudes. In particular, with the labor market softening and consumer price inflation elevated, real earnings have been stagnant so far this year. Declining values and equities in house have taken their toll on household balance sheets, credit conditions have tightened, and indicators of consumer sentiment have fallen sharply. More positively, the fiscal stimulus package is providing some timely support to household incomes. Overall, consumption spending seems likely to be restrained over coming quarters. In the business sector, real outlays for equipment and software were about flat in the first quarter of the year, and construction of nonresidential structures slowed appreciably. In the second quarter, the available data suggests that business fixed investment appears to have expanded moderately. Nevertheless, surveys of capital spending plans indicate that firms remain concerned about the economic and financial environment, including sharply rising costs of inputs and indications of tightening credit, and they are likely to be cautious with spending in the second half of the year. However, strong export growth continues to be a significant boon to many U.S. companies. In conjunction with the June FOMC meeting, Board members and reserve bank presidents prepared economic projections covering the years 2008 through 2010. On balance, most FOMC participants expected that, over the remainder of this year, output would expand at a pace appreciably below its trend rate, primarily because of continued weakness in housing markets, elevated energy prices, and tight credit conditions. Growth is projected to pick up gradually over the next 2 years as residential construction bottoms out and begins a slow recovery and as credit conditions gradually improve. However, FOMC participants indicated that considerable uncertainty surrounded their outlook for economic growth, and they viewed the risks to their forecast as skewed to the downside. Inflation has remained high, running at nearly a 3.5-percent annual rate over the first 5 months of this year, as measured by the price index of personal consumption expenditures. And with gasoline and other consumer energy prices rising in recent weeks, inflation seems likely to move temporarily higher in the near term. The elevated level of overall consumer inflation largely reflects a continued sharp run-up in the prices of many commodities, especially oil, but also certain crops and metals. The spot price of West Texas intermediate crude oil soared about 60 percent in 2007 and thus far this year has climbed an additional 50 percent or so. The price of oil currently stands at about 5 times its level toward the beginning of this decade. Our best judgment is that this surge in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets. Over the past several years, the world economy has expanded at its fastest pace in decades, leading to substantial increases in demand for oil. Moreover, growth has been concentrated in developed and emerging market economies, where energy consumption has been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users. On the supply side, despite sharp increases in prices, the production of oil has risen only slightly in the past few years. Much of the subdued supply response reflects inadequate investment and production shortfalls in politically volatile regions where large portions of the world's oil reserves are located. Additionally, many governments have been tightening their control over oil resources, impeding foreign investment and hindering efforts to boost capacity and production. Finally, sustainable rates of production in some of the more secure and accessible oil fields, such as those in the North Sea, have been declining. In view of these factors, estimates of long-term oil supplies have been marked down in recent months. Long-dated oil future prices have risen along with spot prices, suggesting that market participants also see oil supply conditions remaining tight for years to come. The decline in the foreign exchange value of the dollar has also contributed somewhat to the increase in oil prices. The precise size of this effect is difficult to ascertain as the causal relationships between oil prices and the dollar are complex and run in both directions. However, the price of oil has risen significantly in terms of all major currencies, suggesting that factors other than the dollar--notably, shifts in the underlying global demand for and supply of oil--have been the principal drivers of these increases in prices. Another concern that has been raised is that financial speculation has added markedly to upward pressure on oil prices. Certainly, investor interest in oil and other commodities has increased substantially of late. However, if financial speculation is pushing oil prices above the levels consistent with the fundamentals of supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell. But, in fact, available data on oil inventories show notable declines over the past year. This is not to say that useful steps could not be taken to improve the transparency and functioning of futures markets, only that such steps are unlikely to substantially affect the prices of oil or other commodities in the longer term. Although the inflationary effect of rising oil and agricultural commodity prices is evident in the retail prices of energy and food, the extent to which the high prices of oil and other raw materials have passed through to the prices of non-energy, non-food finished goods and services seems thus far to have been limited. But with businesses facing persistently higher input prices, they may attempt to pass through such costs into prices of final goods and services more aggressively than they have done so far. Moreover, as the foreign exchange value of the dollar has declined, rises in import prices have put greater upward pressure on business costs and consumer prices. In their economic projections for the June FOMC meeting, monetary policymakers marked up their forecasts for inflation during 2008 as a whole. FOMC participants continue to expect inflation to moderate in 2009 and 2010 as slower global growth leads to a pooling of commodity markets, as pressures on resource utilization decline, and as longer-term inflation expectations remain reasonably well anchored. However, in light of persistent escalation of commodity prices in recent quarters, FOMC participants view the inflation outlook as unusually uncertain and cited the possibility that commodity prices will continue to rise as an important risk to the inflation forecast. Moreover, the currently high level of inflation, if sustained, might lead the public to revise up its expectations for longer-term inflation. If that were to occur and those revised expectations were to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual inflation over the longer term. A critical responsibility of monetary policymakers is to prevent that process from taking hold. At present, accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policymakers. The possibility of higher energy prices, tighter credit conditions, and a still deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately as the rising prices of energy and some other commodities have led to a sharp pick-up in inflation, and some measures of inflation expectations have moved higher. Given the high degree of uncertainty, monetary policymakers will need to carefully assess incoming information bearing on the outlook for both inflation and growth. In light of the increase in upside inflation risk, we must be particularly alert to any indications, such as erosion of longer-term inflation expectations, that the inflationary impulses from commodity prices are becoming embedded in the domestic wage- and price-setting process. I would like to conclude my remarks by providing a brief update on some of the Federal Reserve's actions in the area of consumer protection. At the time of our report last February, I described the Board's proposal to adopt comprehensive new regulations to prohibit unfair or deceptive practices in the mortgage market using our authority under the Home Ownership and Equity Protection Act of 1994. After reviewing more than 4,500 comment letters we received on these proposed rules, the Board approved the final rules yesterday. The new rules apply to all types of mortgage lenders and will establish lending standards aimed at curbing abuses while preserving responsible subprime lending and sustainable homeownership. The final rules prohibit lenders from making higher-priced loans without due regard for consumers' ability to make the scheduled payments and require lenders to verify the income and assets on which they rely when making the credit decision. Also, for higher-priced loans, lenders now will be required to establish escrow accounts so that property taxes and insurance costs will be included in consumers' regular monthly payments. The final rules also prohibit prepayment penalties for higher-priced loans in cases in which the consumer's payment could increase during the first few years and restrict prepayment penalties on other higher-priced loans. Other measures address the coercion of appraisers' service or practices and other issues. We believe the new rules will help to restore confidence in the mortgage market. In May, working jointly with the Office of Thrift Supervision and the National Credit Union Administration, the Board issued proposed rules under the Federal Trade Commission Act to address unfair or deceptive practices for credit card accounts and overdraft protection plans. Credit cards provide a convenient source of credit for many consumers, but as the terms of credit card loans have become more complex, transparency has been reduced. Our consumer testing has persuaded us that disclosures alone cannot solve this problem. Thus, the Board's proposed rules will require card issuers to alter their practices in ways that will allow consumers to better understand how their own decisions and actions will affect their costs. Card issuers would be prohibited from increasing interest rates retroactively to cover prior purchases, except under very limited circumstances. For accounts having multiple interest rates, when consumers seek to pay down their balance by paying more than the minimum, card issuers would be prohibited from maximizing interest charges by applying excess payments to the lowest-rate balance first. The proposed rules dealing with bank overdraft services seek to give consumers greater control by ensuring that they have ample opportunity to opt out of automatic payments of overdrafts. The Board has already received more than 20,000 comment letters in response to these proposed rules. Thank you very much. I would be pleased to take your questions. " FOMC20070807meeting--55 53,MR. MOSKOW.," Thank you, Mr. Chairman. Conditions in the Seventh District have changed little since our last meeting. We continue to lag the nation largely because of difficulties in the auto industry. Our contacts thought that the U.S. economy had softened a little since June but that international sales continue to be strong. They also voiced continuing concerns about input cost pressures. There is no good news to report on residential construction. Some of my contacts again pushed back their expectations on when housing markets would begin to improve and are now saying later in 2008. We did hear some upbeat comments from our directors about nonresidential construction in the District, but manufacturers of heavy equipment indicated that they were seeing less demand for products that are used in nonresidential construction. We also heard some less-optimistic reports about consumer spending. A major shopping center developer and operator scaled back his expectations for the second half of this year and now thinks that spending will be softer than in the first half. In addition, a large national specialty retailer saw a broad-based slowing in its sales over the past six weeks. Still, no one was overly pessimistic. In our own forecast, we assume that the weakness in consumption relative to trend during the second quarter was largely transitory, perhaps a reaction to the run-up in gasoline prices. Regarding the motor vehicle sector, the major topic of discussion is the current labor negotiations and the possibility of a strike in September. I get the sense that the odds of a walkout are small because both the automakers and the UAW think that a strike would be very damaging. As our director who heads the Michigan AFL-CIO noted, a strike would be mutually assured destruction. The UAW realizes that the negotiations are occurring against the backdrop of very bad economic conditions in the traditional automaking regions. For example, since 2000, Michigan has lost 400,000 jobs. That’s an 8½ percent decline in employment. A strike would be seen as just adding to these economic woes. So from all my discussions with management and labor, my impression is that the climate for change underlying these negotiations is stronger than it has been in the past, but I am not sure how big a move the UAW leadership thinks it can get approved by its members. Of course, the major development affecting the forecast since the last round is the turmoil in credit markets that we were talking about earlier. Our director who runs a major private equity firm made a number of interesting comments regarding the difficulties that banks were having selling off loans that had been made to risky borrowers with extremely beneficial terms, such as covenant-lite and an option to accrue interest charges. The bottom line is that he thought that after the current shakeout there would be fewer buyouts and that pricing and terms would become more reflective of risk. Going forward, it seems likely that the market will favor so- called strategic buyers, the nonfinancial firms that are looking for acquisitions that would directly enhance the efficiency and scale of their business operations. So while we are concerned about the negative implications of tighter credit conditions, markets may now do a better job in pricing the tradeoff between risk and return, which is a positive development. So how might these financial developments affect the real economy? If sustained, the fallout of credit market jitters on the stock market and other assets would weigh on spending through the standard wealth-effect channels. With regard to the credit markets themselves, the key question is how many of the deals that are now being canceled or scaled back would have resulted in an expansion of business activity as opposed to simply transferring ownership. Given the modest changes in interest rates on higher-rated debt, continued growth in C&I lending, and ample internal funds of nonfinancial firms, the cost of capital for most investment projects probably has not risen substantially. So the first-order effects on spending will likely be limited. Of course, this could change quickly in the current volatile markets, and we will need to monitor these developments carefully, or should I say you will need to monitor these developments carefully. [Laughter] However, right now, putting all these factors together, we view the developments in credit markets as a risk to the near-term forecast but not a reason to lower the outlook for growth very much. That said, we, like the Greenbook, have marked down our assumptions concerning potential. We now see potential as a bit above 2½ percent. However, relative to potential, our forecast for real activity is not much different from last round. We see growth averaging close to potential in the second half of ’07, which is stronger than the Greenbook, but running a touch below potential in ’08 and ’09, which is similar to the Greenbook. Our inflation forecast also has not changed much since June. We still see core PCE prices increasing a shade below 2 percent by 2009. But I must say I remain concerned about the inflation forecast. The standard list of upside risks—the lack of resource slack, cost pass- throughs, inflation expectations—these could break the wrong way and require a policy response. So, if potential output growth is, in fact, significantly lower than our earlier assessment, then you could face some challenges in calibrating policy as the economy and economic agents adjust to the lower trend in productivity growth." CHRG-110shrg50420--90 Mr. Dodaro," And the conditions that were set during the Chrysler period in 1979, that was for a $1.5 billion loan guaranty program at that point in time, and so my advice would be those would be the starting point for the conditions. Here, we are talking about multiple entities with a lot more money at stake, so Congress would be, at its discretion, add additional conditions if it so deemed appropriate. Senator Menendez. Now, at least maybe one, I don't know, maybe more, but one of these companies has suggested the possibility of having a merger with a foreign manufacturer. In that case, would it not be of interest to the United States to ensure that there are some conditions precedent at least on its financial interests in that respect to make sure that, in fact, what we are doing--that may create greater viability for the company at the end of the day, but what we want to ensure is that we are helping a domestic auto industry, not a foreign auto industry. " CHRG-110shrg50414--32 STATEMENT OF SENATOR MEL MARTINEZ Senator Martinez. Thank you, Mr. Chairman. I look forward to hearing from the witnesses, and I will be very, very brief. But I do think it merits for us to look for a moment to how we got here because a lot can be said about the lack of regulation. And I want to associate myself with the excellent comments from Senator Dole. I cannot help but have a sense that a lot of what has transpired here, a lot of what we are dealing with today, has its origins in Fannie Mae and Freddie Mac. And as we look at that, and we try to deal with the current problem, we cannot help but also look back. We have not looked back enough to know how Fannie Mae and Freddie Mac got the entire financial world in the mess that we are in today. One of the problems is that it did not have a world class regulator. And I know it is real popular today and easy to do to just beat up on the Administration and blame everything from tsunamis to hurricanes on them. But having been a part of this Administration and having come to this Congress, and before this very Committee, to testify in 2003, along with then-Secretary of Treasury Snow, to ask for stronger regulation over Fannie and Freddie, to have a world class regulator, I find it just a little troubling to just exactly overlook and not pay some attention to how we got here. And I do want to recall also Chairman Greenspan's comments in 2005 before this Committee where he said that if Fannie and Freddie continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolio--which they need to do for interest rate aversion--they potentially create ever growing potential systemic risk down the road. And that is where we are today, systemic risk. So that is just a little bit on how we got here, where I think we need to, Director Lockhart, I hope we are going to drill down and find out a lot more about how Fannie and Freddie got us here. But beyond that, we need to do what we need to do now. We need, in the long term, to also deal with a complete revamping of our regulatory scheme of our financial institutions. But that will come in the future. For now, I believe we are saddled with a problem that needs and requires action, that action needs to be thoughtful but timely. We need to talk about oversight. We need to talk about the size of this fund, and whether it will work or not. But it does appear to me that there are also some questions that we need to have answered, which is if the underlying problem regarding this entire matter has to do with the ever declining home values, what are we doing here that will help to stem that decline in home values? It seems to me, when we look at the State of Florida, that it is about a tremendous inventory of unsold properties, as well as the availability of credit. Hopefully, what we are doing here may help with the availability of credit. But certainly the tremendous inventory is something that I think we also need to address. So I look forward to hearing the testimony from the witnesses, having many questions answered. But at the end of the day, I do believe that it is our responsibility to act, to act timely, and to act responsibly but yet to act. Thank you, Mr. Chairman. " FOMC20080625meeting--256 254,MR. ROSENGREN.," One last question. Sorry for so many questions. The situation of Lehman was kind of interesting because you saw their stock price go down. Talking to financial institutions, both regulated and unregulated, in Boston, a lot of people were evaluating counterparty risk and deciding whether or not they were going to start running before the capital issue. Did your measures of liquidity pick up the amount of stress that was going on in the counterparty analysis being done, I assume, all over the country? One of the conditions for an institution's access to the discount window at a primary credit rate is that it not be rated a 4 or a 5. I know we're not doing bank exams, and I know we're not looking at all the elements of the bank exam. How confident are we, if we were to do something like that for Lehman or for Merrill Lynch, that we wouldn't rate them a 4 or a 5? " CHRG-111hhrg53021Oth--199 Secretary Geithner," Congressman, I am very worried about that risk. I spent a large part of my professional life in trying to make sure we have more cooperation, more uniform standards, partly to reduce that risk. But my general view is that our system is stronger, has been stronger over time where we were prepared to take the leadership role in strengthening protections for investors and providing greater protections against systemic risk. Where we got that right in the past, it proved to be a great competitive asset to our financial institutions and our markets in the past. I think that basic philosophy should underpin what we do. But as you pointed out, because technology has made it much more easy for capital to move where standards are lowest, we have to do a much better job, as we raise standards here, in trying to bring the world with us. And you will be able to watch with us how successful we are in that. But I believe deeply in the importance of that, and you are right to underscore the importance. " CHRG-111hhrg53021--199 Secretary Geithner," Congressman, I am very worried about that risk. I spent a large part of my professional life in trying to make sure we have more cooperation, more uniform standards, partly to reduce that risk. But my general view is that our system is stronger, has been stronger over time where we were prepared to take the leadership role in strengthening protections for investors and providing greater protections against systemic risk. Where we got that right in the past, it proved to be a great competitive asset to our financial institutions and our markets in the past. I think that basic philosophy should underpin what we do. But as you pointed out, because technology has made it much more easy for capital to move where standards are lowest, we have to do a much better job, as we raise standards here, in trying to bring the world with us. And you will be able to watch with us how successful we are in that. But I believe deeply in the importance of that, and you are right to underscore the importance. " FOMC20080805meeting--134 132,MR. WARSH.," Thank you, Mr. Chairman. I have no material changes to report in my view on the overall state of financial stability, growth, or inflation; but as I talked about at the last meeting, it still is likely to be a long, hot summer, and we're only about half over with it. I'll talk first about financial institutions--make maybe four or five points--and then turn quickly to the economy and inflation. First, on financial institutions, I think the body blow that the financial markets and the real economy have taken because of the turmoil at the GSEs is not complete. It is easy for those of us in Washington to forget that bill signings don't always solve problems. I'd say, if the last thing that happens on GSEs is that the bill was signed two weeks ago and action isn't taken in the coming weeks and months, then I would be surprised if we could get through this period without more GSE turmoil finding its way onto the front pages. Second, in terms of financial market conditions, the fall in oil prices and the rest of the energy complex is, indeed, good news, but it strikes me that it has camouflaged an even tougher period for financial institutions than would otherwise be the case. That is, financial institutions somehow look a little more resilient, but I think part of that is only because of the negative correlation that's developed in recent times between equity prices of financials and oil prices. The financial institutions themselves strike me as being in worse condition than market prices would suggest. Third, capital raising, as we have long talked about, is essential to the fix among financial institutions. The way I best describe capital raising over maybe the last nine months is that the first round of capital raising, which was in November and December, was really the vanity round. This consisted of very limited due diligence, sovereign wealth funds signing up, issuers relying upon their vaunted global brands, and capital being raised in a matter of days. The second round probably took us to the spring, a round that I'd call the confessional round. [Laughter] In this round, financial institutions said, ""Oh my, look at these real write-downs that I have. Look at the need for this real capital raising, and here I'm telling you, the investors, all that I know."" But the second and third confessions usually have less credibility than the first. The third round is the round that we're in the middle of, which I think of as the liquidation and recap round, likely to be the hardest round to pull off. It is likely to force issuers of new shares or of new forms of preferred stock to be asking of themselves and their investors the toughest choices. They have to assess the strength and durability of their core franchises. I think that this will be happening in very real time. So the circumstance of an investment bank that Bill mentioned at the outset I don't think will be the sole case of this. This liquidation and recap round is later than would be ideal from the perspective of the broader economy, but it is absolutely needed. Until we see how it occurs, it's hard for me to be much more sanguine that the capital markets or the credit markets will be returning to anything like normal anytime soon. Let me make a fourth broad point about financial institutions. Because of these different phases of capital raise, I think management credibility among financial institutions is at least as suspect as it has ever been during this period. Even new management teams that have come in have in some ways used up a lot of their credibility. It would be nice to believe that they have taken all actions necessary to protect their franchises and their businesses, but most stakeholders are skeptical that they've taken significant or sufficient action. At the end of the day, no matter where policy comes out in terms of regulatory policy from the Fed and other bank regulators or accounting policy from the SEC or FASB, it strikes me that those changes in policy are less determinative of how things shake out. That is, management credibility is so in question that the cure is not likely to come from accounting rules or regulators but from the markets' believing that what management says is what management believes and will act on it. As a result, I think that many of these financial institutions are operating in a zero-defect world, which is posing risks to the real economy. Fifth, let me make a final point about financials. We've all talked a lot about the effect of different curves for housing prices on the financial institutions themselves. I don't mean to give short shrift to any of that, but I would say that the level of uncertainty and associated risks of their non-housing-related assets are now very much a focus. According to July 2008 data, of credit currently being extended by banks, only about 20 percent is for residential real estate. Only about 9 percent is for consumer credit. So that leaves the balance in areas where these financial institutions and their management teams have to be asking themselves whether the weaknesses that are emerging in the real economy will place uncertainty over assets that have nothing to do with housing. That's a major downside risk for financial institutions and has not been much of a focus of shareholder and stakeholder concerns. There are two open issues that will guide some of our thinking, at least with respect to these credit markets. First, as we talked about a little last night with the presidents, are the embedded losses so great at such a critical mass of institutions with management credibility so low that many more than currently expected might be unable to survive? This is a question that I'm not sure I know the answer to. Second, despite the concerns about the effect of the credit markets on the broader economy that I talked about, our monetary policy may not be terribly well suited to be fixing those problems, and financial institutions may not be terribly sensitive to the extent we decide that we should change the stance of policy. Taking all that into account, let me say a couple of words about growth and inflation. First, on the economic growth front, given my views of what's happening in the credit markets, it's very hard for me to believe that the economy will get back to potential anytime soon. There are continued financial stresses that could last through year-end, and in there could be an upside surprise. Still, all things considered, my base case has second-half growth still above staff estimates owing in part to the productivity we've seen in recent months and the remarkable resiliency of this economy. If we look beyond that horizon, though, toward the Greenbook forecast in 2009 and beyond, I must say I don't really see the inflection point to take us back to economic growth of 2.2 percent or whatever the Greenbook suggests. I think we're going to be in this period of belowtrend growth for quite some time. My own view is that, when the Congress comes back after its August recess, we will be in the middle of a big debate on ""Son of Stimulus"" and that the stimulus probabilities have moved up quite materially. However, it is not at all obvious to me that it will do much in terms of helping the real economy. Outside the United States, I share the view of Governor Kohn, which is that I'd expect global GDP, particularly GDP among advanced foreign economies, our major trading partners, to continue to disappoint, making the remarkable addition of net export growth to our own GDP likely to dissipate. Turning finally to inflation, my view is that inflation risks are very real, and I believe that these risks are higher than growth risks. I don't take that much comfort from the move in commodity prices since we last met. If that trend continues, then that would certainly be good news; but I must say I don't feel as though inflation risks have moved down noticeably since we last had this discussion. The staff expects food prices to continue to be challenging; that is certainly my view. The staff also expects core import prices to fall rather precipitously. I'm a little skeptical of that view. I think it's possible, but I don't really see the catalyst for that given what we see about changes in input prices overseas and given expectations of the dollar in foreign exchange markets. So with that, I think that the inflation risks are real, and I'll save the balance of my remarks for the next round. Thank you, Mr. Chairman. " CHRG-111shrg50815--6 STATEMENT OF SENATOR MENENDEZ Senator Menendez. I will make a brief statement. I don't know about very brief, Mr. Chairman. I will make a brief statement. Senator Schumer. Moderately brief. [Laughter.] Senator Menendez. Moderately brief. Let me thank the Chairman for holding this hearing. Credit card reform has been one of the top priorities that I have had both in the House and in the Senate since I arrived here, and I think this hearing couldn't come at a more important time, when millions of Americans are increasingly using their credit cards to float their basic necessities from month to month. As a result, Americans have almost $1 trillion of credit card debt outstanding. It seems to me that it is a dangerous cycle that is piling up. And while that debt is piling up, people in our State and across the country are discovering that their credit card agreements often conceal all kinds of trap doors behind a layer of fine print. If you take one false step, then your credit rating plummets and your interest rate shoots through the roof. Many of my constituents have contacted me after facing sky-high interest rates they never expected after accepting one offer, only to learn later that the terms seem to have been written in erasable ink, or after watching in horror as their children in college get swallowed in debt. So for far too many people, credit card is already a personal financial crisis and I believe it is a national crisis. Our economy will not recover if debt ties down consumers tighter and tighter, and making credit card lending practices fairer would be the right thing to do under any circumstances, but under these economic conditions, it is an absolute necessity. Mr. Chairman, I have legislation, as well. Some of it has been incorporated in what I think Chairman Dodd is going to include. I appreciate those efforts and I hope that the Federal Reserve's guidelines, which are a good step, could actually be accelerated, because waiting a year and a half to get those guidelines into place at a critical time in our economy is only buying us more and more challenges. With that, Mr. Chairman, I ask that the rest of my statement be included in the record. Senator Johnson. Senator Schumer, do you have a very brief statement? CHRG-111shrg56415--83 PREPARED STATEMENT OF DANIEL K. TARULLO Member, Board of Governors of the Federal Reserve System October 14, 2009 Chairman Johnson, Ranking Member Crapo, and members of the Subcommittee, thank you for your invitation to discuss the condition of the U.S. banking industry. First, I will review the current conditions in financial markets and the overall economy and then turn to the performance of the banking system, highlighting particular challenges in commercial real estate (CRE) and other loan portfolios. Finally, I will address the Federal Reserve's regulatory and supervisory responses to these challenges.Conditions in Financial Markets and the Economy Conditions and sentiment in financial markets have continued to improve in recent months. Pressures in short-term funding markets have eased considerably, broad stock price indexes have increased, risk spreads on corporate bonds have narrowed, and credit default swap spreads for many large bank holding companies, a measure of perceived riskiness, have declined. Despite improvements, stresses remain in financial markets. For example, corporate bond spreads remain quite high by historical standards, as both expected losses and risk premiums remain elevated. Economic growth appears to have moved back into positive territory last quarter, in part reflecting a pickup in consumer spending and a slight increase in residential investment--two components of aggregate demand that had dropped to very low levels earlier in the year. However, the unemployment rate has continued to rise, reaching 9.8 percent in September, and is unlikely to improve materially for some time. Against this backdrop, borrowing by households and businesses has been weak. According to the Federal Reserve's Flow of Funds accounts, household and nonfinancial business debt contracted in the first half of the year and appears to have decreased again in the third quarter. For households, residential mortgage debt and consumer credit fell sharply in the first half; the decline in consumer credit continued in July and August. Nonfinancial business debt also decreased modestly in the first half of the year and appears to have contracted further in the third quarter as net decreases in commercial paper, commercial mortgages, and bank loans more than offset a solid pace of corporate bond issuance. At depository institutions, loans outstanding fell in the second quarter of 2009. In addition, the Federal Reserve's weekly bank credit data suggests that bank loans to households and to nonfinancial businesses contracted sharply in the third quarter. These declines reflect the fact that weak economic growth can both damp demand for credit and lead to tighter credit supply conditions. The results from the Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending Practices indicate that both the availability and demand for bank loans are well below pre-crisis levels. In July, more banks reported tightening their lending standards on consumer and business loans than reported easing, although the degree of net tightening was well below levels reported last year. Almost all of the banks that tightened standards indicated concerns about a weaker or more uncertain economic outlook, and about one-third of banks surveyed cited concerns about deterioration in their own current or future capital positions. The survey also indicates that demand for consumer and business loans has remained weak. Indeed, decreased loan demand from creditworthy borrowers was the most common explanation given by respondents for the contraction of business loans this year. Taking a longer view of cycles since World War II, changes in debt flows have tended to lag behind changes in economic activity. Thus, it would be unusual to see a return to a robust and sustainable expansion of credit until after the overall economy begins to recover. Credit losses at banking organizations continued to rise through the second quarter of this year, and banks face risks of sizable additional credit losses given the outlook for production and employment. In addition, while the decline in housing prices slowed in the second quarter, continued adjustments in the housing market suggest that foreclosures and mortgage loan loss severities are likely to remain elevated. Moreover, prices for both existing commercial properties and for land, which collateralize commercial and residential development loans, have declined sharply in the first half of this year, suggesting that banks are vulnerable to significant further deterioration in their CRE loans. In sum, banking organizations continue to face significant challenges, and credit markets are far from fully healed.Performance of the Banking System Despite these challenges, the stability of the banking system has improved since last year. Many financial institutions have been able to raise significant amounts of capital and have achieved greater access to funding. Moreover, through the rigorous Supervisory Capital Assessment Program (SCAP) stress test conducted by the banking agencies earlier this year, some institutions demonstrated that they have the capacity to withstand more-adverse macroeconomic conditions than are expected to develop and have repaid the government's Troubled Asset Relief Program (TARP) investments.\1\ Depositors' concerns about the safety of their funds during the immediate crisis last year have also largely abated. As a result, financial institutions have seen their access to core deposit funding improve.--------------------------------------------------------------------------- \1\ For more information about the SCAP, see Ben S. Bernanke (2009), ``The Supervisory Capital Assessment Program,'' speech delivered at the Federal Reserve Bank of Atlanta 2009 Financial Markets Conference, held in Jekyll Island, Ga., May 11, www.Federalreserve.gov/newsevents/speech/bernanke20090511a.htm.--------------------------------------------------------------------------- However, the banking system remains fragile. Nearly 2 years into a substantial recession, loan quality is poor across many asset classes and, as noted earlier, continues to deteriorate as lingering weakness in housing markets affects the performance of residential mortgages and construction loans. Higher loan losses are depleting loan loss reserves at many banking organizations, necessitating large new provisions that are producing net losses or low earnings. In addition, although capital ratios are considerably higher than they were at the start of the crisis for many banking organizations, poor loan quality, subpar earnings, and uncertainty about future conditions raise questions about capital adequacy for some institutions. Diminished loan demand, more-conservative underwriting standards in the wake of the crisis, recessionary economic conditions, and a focus on working out problem loans have also limited the degree to which banks have added high quality loans to their portfolios, an essential step to expanding profitable assets and thus restoring earnings performance. These developments have raised the number of problem banks to the highest level since the early 1990s, and the rate of bank and thrift failures has accelerated throughout the year. Moreover, the estimated loss rates for the deposit insurance fund on bank failures have been very high, generally hovering near 30 percent of assets. This high loss level reflects the rapidity with which loan quality has deteriorated during the crisis and suggests that banking organizations may need to continue their high level of loan loss provisioning for some time. Moreover, some of these institutions, including those with capital above minimum requirements, may need to raise more capital and restrain their dividend payouts for the foreseeable future. Indeed, the buildup in capital ratios at large banking organizations has been essential to reassuring the market of their improving condition. However, we must recognize that capital ratios can be an imperfect indicator of a bank's overall strength, particularly in periods in which credit quality is deteriorating rapidly and loan loss rates are moving higher.Comparative Performance of Banking Institutions by Asset Size Although the broad trends detailed above have affected all financial institutions, there are some differences in how the crisis is affecting large financial institutions and more locally focused community and regional banks. Consider, for example, the 50 largest U.S. bank holding companies, which hold more than three-quarters of bank holding company assets and now include the major investment banks in the United States. While these institutions do engage in traditional lending activities, originating loans and holding them on their balance sheets like their community bank competitors, they also generate considerable revenue from trading and other fee-based activities that are sensitive to conditions in capital markets. These firms reported modest profits during each of the first two quarters of 2009. Second-quarter net income for these companies at $1.6 billion was weaker than that of the first quarter, but was still a great improvement over the $19.8 billion loss reported for the second quarter of last year. Net income was depressed by the payment of a significant share of the Federal Deposit Insurance Corporation's (FDIC) special deposit insurance assessment and a continued high level of loan loss provisioning. Contributing significantly to better performance was the improvement of capital markets activities and increases in related fees and revenues. Community and small regional banks have also benefited from the increased stability in financial markets. However, because they depend largely on revenues from traditional lending activities, as a group they have yet to report any notable improvement in earnings or condition since the crisis took hold. These banks--with assets of $10 billion or less representing almost 7,000 banks and 20 percent of commercial bank assets--reported a $2.7 billion loss in the second quarter. Earnings remained weak at these banks due to a historically narrow net interest margin and high loan loss provisions. More than one in four of these banks reported a net loss. Earnings at these banks were also substantially affected by the FDIC special assessment during the second quarter. Loan quality deteriorated significantly for both large and small institutions during the second quarter. At the largest 50 bank holding companies, nonperforming assets climbed more than 20 percent, raising the ratio of nonperforming assets to 4.3 percent of loans and other real estate owned. Most of the deterioration was concentrated in residential mortgage and construction loans, but commercial, CRE, and credit card loans also experienced rising delinquency rates. Results of the banking agencies' Shared National Credit review, released in September, also document significant deterioration in large syndicated loans, signaling likely further deterioration in commercial loans.\2\ At community and small regional banks, nonperforming assets increased to 4.4 percent of loans at the end of the second quarter, more than six times the level for this ratio at year-end 2006, before the crisis started. Home mortgages and CRE loans accounted for most of the increase, but commercial loans have also shown marked deterioration during recent quarters. Importantly, aggregate equity capital for the top 50 bank holding companies, and thereby for the banking industry, increased for the third consecutive quarter and reached 8.8 percent of consolidated assets as of June 30, 2009. This level was almost 1 percentage point above the year-end 2008 level and exceeded the pre-crisis level of midyear 2007 by more than 2 percentage points. Risk-based capital ratios for the top 50 bank holding companies also remained relatively high: Tier 1 capital ratios were at 10.75 percent, and total risk-based capital ratios were at 14.09 percent. Signaling the recent improvement in financial markets since the crisis began, capital increases during the first half of this year largely reflected common stock issuance, supported also by reductions in dividend payments. However, asset contraction also accounts for part of the improvement in capital ratios. Additionally, of course, the Treasury Capital Purchase Program also contributed to the increase in capital in the time since the crisis emerged.--------------------------------------------------------------------------- \2\ See Board of Governors of the Federal Reserve System, FDIC, Office of the Comptroller of the Currency, and Office of Thrift Supervision (2009), ``Credit Quality Declines in Annual Shared National Credits Review,'' joint press release, September 24, www.Federalreserve.gov/newsevents/press/bcreg/20090924a.htm.--------------------------------------------------------------------------- Despite TARP capital investments in some banks and the ability of others to raise equity capital, weak earnings led to modest declines in the average capital ratios of smaller banks over the past year--from 10.7 percent to 10.4 percent of assets as of June 30 of this year. However, risk-based capital ratios remained relatively high for most of these banks, with 96 percent maintaining risk-based capital ratios consistent with a ``well capitalized'' designation under prompt corrective action standards. Funding for the top 50 bank holding companies has improved markedly over the past year. In addition to benefiting from improvement in interbank markets, these companies increased core deposits from 24 percent of total assets at year-end 2008 to 27 percent as of June 30, 2009. The funding profile for community and small regional banks also improved, as core deposit funding rose to 62 percent of assets and reliance on brokered deposits and Federal Home Loan Bank advances edged down from historically high levels. As already noted, substantial financial challenges remain for both large and small banking institutions. In particular, some large regional and community banking firms that have built up unprecedented concentrations in CRE loans will be particularly affected by emerging conditions in real estate markets. I will now discuss the economic conditions and financial market dislocations affecting CRE markets and the implications for banking organizations.Current Conditions in Commercial Real Estate Markets Prices of existing commercial properties are estimated to have declined 35 to 40 percent since their peak in 2007, and market participants expect further declines. Demand for commercial property has declined as job losses have accelerated, and vacancy rates have increased. The higher vacancy levels and significant decline in the value of existing properties have placed particularly heavy pressure on construction and development projects that generate no income until completion. Developers typically depend on the sales of completed projects to repay their outstanding loans, and with the volume of property sales at especially low levels and with prices depressed, the ability to service existing construction loans has been severely impaired. The negative fundamentals in the CRE property markets have caused a sharp deterioration in the credit performance of loans in banks' portfolios and loans in commercial mortgage-backed securities (CMBS). At the end of the second quarter of 2009, approximately $3.5 trillion of outstanding debt was associated with CRE, including loans for multifamily housing developments. Of this, $1.7 trillion was held on the books of banks and thrifts, and an additional $900 billion represented collateral for CMBS, with other investors holding the remaining balance of $900 billion. Also at the end of the second quarter, about 9 percent of CRE loans on banks' books were considered delinquent, almost double the level of a year earlier.\3\ Loan performance problems were the most striking for construction and development loans, especially for those that finance residential development. More than 16 percent of all construction and development loans were considered delinquent at the end of the second quarter.--------------------------------------------------------------------------- \3\ The CRE loans considered delinquent on banks' books were non-owner occupied CRE loans that were 30 days or more past due.--------------------------------------------------------------------------- Almost $500 billion of CRE loans will mature each year over the next few years. In addition to losses caused by declining property cash-flows and deteriorating conditions for construction loans, losses will also be boosted by the depreciating collateral value underlying those maturing loans. These losses will place continued pressure on banks' earnings, especially those of smaller regional and community banks that have high concentrations of CRE loans. The current fundamental weakness in CRE markets is exacerbated by the fact that the CMBS market, which had financed about 30 percent of originations and completed construction projects, has remained virtually inoperative since the start of the crisis. Essentially no CMBS have been issued since mid-2008. New CMBS issuance came to a halt as risk spreads widened to prohibitively high levels in response to the increase in CRE-specific risk and the general lack of liquidity in structured debt markets. Increases in credit risk have significantly softened demand in the secondary trading markets for all but the most highly rated tranches of these securities. Delinquencies of mortgages backing CMBS have increased markedly in recent months. Market participants anticipate these rates will climb higher by the end of this year, driven not only by negative fundamentals but also by borrowers' difficulty in rolling over maturing debt. In addition, the decline in CMBS prices has generated significant stresses on the balance sheets of financial institutions that must mark these securities to market, further limiting their appetite for taking on new CRE exposure.Federal Reserve Activities to Help Revitalize Credit Markets The Federal Reserve, along with other government agencies, has taken a number of actions to strengthen the financial sector and to promote the availability of credit to businesses and households. In addition to aggressively easing monetary policy, the Federal Reserve has established a number of facilities to improve liquidity in financial markets. One such program is the Term Asset-Backed Securities Loan Facility (TALF), begun in November 2008 to facilitate the extension of credit to households and small businesses. Before the crisis, securitization markets were an important conduit of credit to the household and business sectors; some have referred to these markets as the ``shadow banking system.'' Securitization markets (other than those for mortgages guaranteed by the government) have virtually shut down since the onset of the crisis, eliminating an important source of credit. Under the TALF, eligible investors may borrow to finance purchases of the AAA-rated tranches of certain classes of asset-backed securities. The program originally focused on credit for households and small businesses, including auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. More recently, CMBS were added to the program, with the goal of mitigating a severe refinancing problem in that sector. The TALF has had some success. Rate spreads for asset-backed securities have declined substantially, and there is some new issuance that does not use the facility. By improving credit market functioning and adding liquidity to the system, the TALF and other programs have provided critical support to the financial system and the economy.Availability of Credit The Federal Reserve has long-standing policies in place to support sound bank lending and the credit intermediation process. Guidance issued during the CRE downturn in 1991 instructs examiners to ensure that regulatory policies and actions do not inadvertently curtail the availability of credit to sound borrowers.\4\ This guidance also states that examiners should ensure loans are being reviewed in a consistent, prudent, and balanced fashion to prevent inappropriate downgrades of credits. It is consistent with guidance issued in early 2007 addressing risk management of CRE concentrations, which states that institutions that have experienced losses, hold less capital, and are operating in a more risk-sensitive environment are expected to employ appropriate risk-management practices to ensure their viability.\5\--------------------------------------------------------------------------- \4\ See Board of Governors of the Federal Reserve System, Division of Banking Supervision and Regulation (1991), ``Interagency Examination Guidance on Commercial Real Estate Loans,'' Supervision and Regulation Letter SR 91-24 (November 7), www.Federalreserve.gov/BoardDocs/SRLetters/1991/SR9124.htm; and Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Federal Reserve Board, and Office of Thrift Supervision (1991), ``Interagency Policy Statement on the Review and Classification of Commercial Real Estate Loans,'' joint policy statement, November 7, www.Federalreserve.gov/BoardDocs/SRLetters/1991/SR9124a1.pdf. \5\ See Board of Governors of the Federal Reserve System, Division of Banking Supervision and Regulation (2007), ``Interagency Guidance on Concentrations in Commercial Real Estate,'' Supervision and Regulation Letter SR 07 1 (January 4), www.Federalreserve.gov/boarddocs/srletters/2007/SR0701.htm.--------------------------------------------------------------------------- We are currently in the final stages of developing interagency guidance on CRE loan restructurings and workouts. This guidance supports balanced and prudent decisionmaking with respect to loan restructuring, accurate and timely recognition of losses and appropriate loan classification. The guidance will reiterate that classification of a loan should not be based solely on a decline in collateral value, in the absence of other adverse factors, and that loan restructurings are often in the best interest of both the financial institution and the borrower. The expectation is that banks should restructure CRE loans in a prudent manner, recognizing the associated credit risk, and not simply renew a loan in an effort to delay loss recognition. On one hand, banks have raised concerns that our examiners are not always taking a balanced approach to the assessment of CRE loan restructurings. On the other hand, our examiners have observed incidents where banks have been slow to acknowledge declines in CRE project cash-flows and collateral values in their assessment of the potential loan repayment. This new guidance, which should be finalized shortly, is intended to promote prudent CRE loan workouts as banks work with their creditworthy borrowers and to ensure a balanced and consistent supervisory review of banking organizations. Guidance issued in November 2008 by the Federal Reserve and the other Federal banking agencies encouraged banks to meet the needs of creditworthy borrowers, in a manner consistent with safety and soundness, and to take a balanced approach in assessing borrowers' ability to repay and making realistic assessments of collateral valuations.\6\ In addition, the Federal Reserve has directed examiners to be mindful of the effects of excessive credit tightening in the broader economy and we have implemented training for examiners and outreach to the banking industry to underscore these intentions. We are aware that bankers may become overly conservative in an attempt to ameliorate past weaknesses in lending practices, and are working to emphasize that it is in all parties' best interests to continue making loans to creditworthy borrowers.--------------------------------------------------------------------------- \6\ See Board of Governors of the Federal Reserve System, FDIC, Office of the Comptroller of the Currency, and Office of Thrift Supervision (2008), ``Interagency Statement on Meeting the Needs of Creditworthy Borrowers,'' joint press release, November 12, www.Federalreserve.gov/newsevents/press/bcreg/20081112a.htm.---------------------------------------------------------------------------Strengthening the Supervisory Process The recently completed SCAP of the 19 largest U.S. bank holding companies demonstrates the effectiveness of forward-looking horizontal reviews and marked an important evolutionary step in the ability of such reviews to enhance supervision. Clearly, horizontal reviews--reviews of risks, risk-management practices and other issues across multiple financial firms--are very effective vehicles for identifying both common trends and institution-specific weaknesses. The SCAP expanded the scope of horizontal reviews and included the use of a uniform set of stress parameters to apply consistently across firms. An outgrowth of the SCAP was a renewed focus by supervisors on institutions' own ability to assess their capital adequacy--specifically their ability to estimate capital needs and determine available capital resources during very stressful periods. A number of firms have learned hard, but valuable, lessons from the current crisis that they are applying to their internal processes to assess capital adequacy. These lessons include the linkages between liquidity risk and capital adequacy, the dangers of latent risk concentrations, the value of rigorous stress testing, the importance of strong governance over their processes, and the importance of strong fundamental risk identification and risk measurement to the assessment of capital adequacy. Perhaps one of the most important conclusions to be drawn is that all assessments of capital adequacy have elements of uncertainty because of their inherent assumptions, limitations, and shortcomings. Addressing this uncertainty is one among several reasons that firms should retain substantial capital cushions. Currently, we are conducting a horizontal assessment of internal processes that evaluate capital adequacy at the largest U.S. banking organizations, focusing in particular on how shortcomings in fundamental risk management and governance for these processes could impair firms' abilities to estimate capital needs. Using findings from these reviews, we will work with firms over the next year to bring their processes into conformance with supervisory expectations. Supervisors will use the information provided by firms about their processes as a factor--but by no means the only factor--in the supervisory assessment of the firms' overall capital levels. For instance, if a firm cannot demonstrate a strong ability to estimate capital needs, then supervisors will place less credence on the firm's own internal capital results and demand higher capital cushions, among other things. Moreover, we have already required some firms to raise capital given their higher risk profiles. In general, we believe that if firms develop more-rigorous internal processes for assessing capital adequacy that capture all the risks facing those firms--including under stress scenarios--and maintain adequate capital based on those processes, they will be in a better position to weather financial and economic shocks and thereby perform their role in the credit intermediation process. We also are expanding our quantitative surveillance program for large, complex financial organizations to include supervisory information, firm-specific data analysis, and market-based indicators to identify developing strains and imbalances that may affect multiple institutions, as well as emerging risks to specific firms. Periodic scenario analyses across large firms will enhance our understanding of the potential impact of adverse changes in the operating environment on individual firms and on the system as a whole. This work will be performed by a multidisciplinary group composed of our economic and market researchers, supervisors, market operations specialists, and accounting and legal experts. This program will be distinct from the activities of onsite examination teams so as to provide an independent supervisory perspective, as well as to complement the work of those teams. As we adapt our internal organization of supervisory activities to build on lessons learned from the current crisis, we are using all of the information and insight that the analytic abilities the Federal Reserve can bring to bear in financial supervision.Conclusion A year ago, the world financial system was profoundly shaken by the failures and other serious problems at large financial institutions here and abroad. Significant credit and liquidity problems that had been building since early 2007 turned into a full-blown panic with adverse consequences for the real economy. The deterioration in production and employment, in turn, exacerbated problems for the financial sector. It will take time for the banking industry to work through these challenges and to fully recover and serve as a source of strength for the real economy. While there have been some positive signals of late, the financial system remains fragile and key trouble spots remain, such as CRE. We are working with financial institutions to ensure that they improve their risk management and capital planning practices, and we are also improving our own supervisory processes in light of key lessons learned. Of course, we are also committed to working with the other banking agencies and the Congress to ensure a strong and stable financial system. ______ CHRG-111hhrg52397--95 Mr. Pickel," If I could just comment, I think that is a very good division of how this market will evolve and is already in the process of evolving. You would have an exchange traded, or perhaps an electronically traded element, that would allow the highly standardized trades to be traded that way. You would have this category of cleared trades and then you would have the customized trades. I think the question of where a product is in the standardization process is largely a function of how actively traded and how liquid the underlying market is because keep in mind a clearinghouse will need to at least daily, and sometimes twice daily, mark those positions to market and call for margin, and so it needs to have a liquid market for that project. An exchange needs an even higher degree of liquidity, market makers who are active in the exchange, ready to do a transaction at any time during the trading day. So that liquidity I think largely drives where the dividing line would be, but that is not an easy determination to make. " CHRG-111hhrg48873--19 Mr. Bernanke," Thank you, Chairman Frank, Ranking Member Bachus, and other members of the committee. I appreciate having this opportunity to discuss the Federal Reserve's involvement with AIG. In my testimony, I will describe why supporting AIG was a difficult but necessary step to protect our economy and stabilize our financial system. I will also discuss issues related to compensation and note two matters raised by this experience that merit congressional attention. We at the Federal Reserve, working closely with the Treasury, made our decision to lend to AIG on September 16th of last year. It was an extraordinary time. Global financial markets were experiencing unprecedented strains and a worldwide loss of confidence. Fannie Mae and Freddie Mac had been placed into conservatorship only 2 weeks earlier, and Lehman Brothers had filed for bankruptcy the day before. We were very concerned about a number of other major firms that were under intense stress. AIG's financial condition had been deteriorating for some time, caused by actual and expected losses on subprime mortgage-backed securities and on credit default swaps that AIG's Financial Products unit, AIG FP, had written on mortgage-related securities. As confidence in the firm declined and with efforts to find a private-sector solution unsuccessful, AIG faced severe liquidity pressures that threatened to force it imminently into bankruptcy. The Federal Reserve and the Treasury agreed that AIG's failure under the conditions then prevailing-- " CHRG-111shrg50815--32 Mr. Clayton," Well, Senator, I know there has always been this discussion about how universal default is defined and I understand respect the fact that people take different perspectives. But it is our understanding that the Fed permits the changing of interest rates on existing balances under four conditions and four conditions alone. The first condition is if it is a promotional rate card, essentially, and it is disclosed ahead of time and that promotional rate expires. The second one is if it is a variable rate card tied to some kind of index. The third one is if there is a delinquency in excess of 30 days. And the fourth one is if it is a violation of a work-out agreement. I am unaware of any other circumstance where, when this rule becomes effective, that institutions can consider off-account information in determining the interest rate on that existing balance. " CHRG-110hhrg44900--162 Secretary Paulson," Let me say what history shows us is that it is very difficulty to predict in advance, and I don't think you're going to be able to reasonably give us any tool right now. So I'm going to just tell you that there is an urgent need. We are not saying take your time, wait. There is an urgent need to get more tools. But I also will tell you that I believe that the focus on market stability and the actions that the Fed has taken, not just in the Bear Stearns episode, but in the follow-up in opening the PDCF to the opening of the diskette window to the investment banks has sent a very strong signal. And the work that the Fed and the SEC has done with these good institutions is a strength in their liquidity management, is, I think, very important. So neither of us are predicting another incident and we are looking at the progress that has been made. We both would like additional tools. We are not saying take forever, but we recognize the fact that the regulatory structure hasn't been changed in a long time and the fact that we don't have these tools mean that it's not going to be easy. It's going to need to be thought through and the sooner the better, but we are prepared to work together, work with you to deal with the situation on the interim. " FOMC20051213meeting--122 120,MS. BIES.," Thank you, Mr. Chairman. First, let me say that I support the 25 basis point increase today. And I give my sympathy to Brian, who has heard our many different viewpoints in the last week. I think he has done a good job of trying to get all our ideas out here in a reasonable balance. My initial feeling was that I really didn’t want to keep the word “measured” in the statement; I wanted to drop it as part of this change. But for the reasons everybody has suggested, I can accept the wording in alternative B as it is now. Mr. Chairman, you talked about some of the risks to the long-term side of the market. I think that is a serious concern because so much of the pricing these days seems not to involve looking at the longer-term risks, and it’s so critical to what is currently driving investment and risk-taking. And for that reason, I guess I’d like to leave the words as they are now. But the big change that I would like to see is a move away from forward-looking language as we get to the point where there is more uncertainty about future policy. It was easy for the last thirteen meetings to say, “We’re on a trend; the funds rate is way too low and we have to get it back up.” So it was easy for us to signal ahead. But as we signaled ahead, the market looked at what we were saying we were going to do as opposed to what the data were saying we would do. We, in effect, have taken the risk away from the market, especially at the long end, because market participants think we’re going to signal ahead of time and they will have time to get out of their long positions. In my view, we should go back to structuring section 4 to say basically where we think the risk is. Then I’d take the second part of that sentence and put it down in section 5, because it’s still a December 13, 2005 83 of 100 around this table is going to say that we’re not going to follow the mission of the Fed. So if we’re going to put in a tautology, I’d put it in part 5. And in part 4 I’d just indicate our assessment of the risks—that we think the risks are balanced or that the risk to growth or for inflation is greater. That would give the markets the message that they need to go back to looking at the data to figure out what we’re going to do, rather than our laying out for them what our next policy moves are going to be. As we get to the cusp, that risk perspective is really important. We saw when we turned from the bottom and rates were heading back up again that it disrupted the markets. But we need the markets to be ready to absorb that kind of risk because, as we sit around this table, we do not know exactly how we’re going to engineer getting out of this pattern of moving 25 basis points at each meeting. And I think the way to do it is to focus on where we see the risks and to stop giving any kind of signal on what our likely moves are going forward. I would like to see that happen at the next meeting." FOMC20080430meeting--97 95,MR. LOCKHART.," Thank you, Mr. Chairman. Our high-level view of current circumstances is that the real economy is quite weak, with weakness widespread. The financial markets are turning optimistic, and elevated prices and inflation remain a serious concern. Reports from our directors and District business contacts were broadly similar to the incoming national data and information from other Districts reported in the Beige Book. Observations from such District input support themes in the national data--for example, employment growth is quite weak. In this round of director reports and conversations, I heard an increasing number of reports of holds on hiring and expansion plans. One representative of a major retailer of home improvement goods reported that hiring for seasonal employees will be down 40 percent this spring. This translates to approximately 45,000 jobs. Nonresidential real estate development continues to slow in the District, especially in Florida and Georgia. Of the 18 commercial contractors contacted in April, 15 expect that commercial construction will be weaker for the rest of 2008 than for the same period in 2007, with several predicting even more pronounced weakness in 2009. On the brighter side, Florida Realtors are anticipating that sales over the next few months will exceed year-ago levels, and builders are signaling less weakness than in recent reports. This is a level of optimism we have not heard from Florida for some time. However, housing markets in the rest of the District continue to weaken. We heard several complaints that obtaining financing is a serious problem for commercial and residential developers and consumer homebuyers. In sum, the information from the Sixth District seems to confirm what I believe is the continuing story of the national real economy captured in the Greenbook--that is, shrinking net job creation, developing weakness in nonresidential construction, and a bottom in the housing market still not in sight. In contrast, conditions in the financial markets appear to have improved substantially. As has been my practice, I had several conversations with contacts in a variety of financial firms. There was a consistent tone suggesting that financial markets are likely to have seen the worst. This does not mean that no concerns were expressed. Some contacts had concerns about European banks and credit markets, and concern about the value of the dollar, notwithstanding the recent rally, is coming up in more contexts. Concern was expressed about the dollar's disruptive effect on commodity markets, in turn affecting the general price level--in particular, the effect of high energy prices on a wide spectrum of businesses' consumer products and even on crime rates in rural and far suburban areas related to the theft of copper wiring and piping from vacant homes and air conditioning units. I worry that a narrative is developing along the lines that the ECB is concerned about inflation and the Fed not so much. This narrative encourages a dollar carry trade mentioned, again, by some financial contacts that puts downside pressure on the dollar that potentially undermines both growth and inflation objectives. I remain concerned about the vulnerability of financial markets to a shock or surprise, but overall, my contacts express the belief that conditions are improving. The Atlanta forecast submission sees flat real GDP growth in the first half of 2008, with gradual improvement in the second half. We continue to believe that the drag on economic activity from the problems in the housing and credit markets will persist into 2009. On the inflation front, I am still projecting a decline in the rate of inflation over this year. I've submitted forecasts of declining headline inflation in 2009 and 2010, but I should note that my staff's current projections suggest that improvement to the degree I would like to see may require some rises in the federal funds rate. It is my current judgment that, with an additional 25 basis point reduction in the fed funds rate target, policy will be appropriately calibrated to the gradual recovery of growth and the lowering of the inflation level envisioned in our forecast. This judgment is based on the view that, with a negative real funds rate by some measures, policy is in stimulative territory; that a lower cost of borrowing in support of growth depends more on market-driven tightening of credit spreads than a lower policy rate; that further cuts may contribute to unhelpful movements in the dollar exchange rate; and that extension of the four liquidity facilities may allow us to decouple liquidity actions from the fed funds rate target. In my view, we are in a zone of diminishing returns from further funds rate cuts beyond a possible quarter in this meeting. That said, as stated in the Greenbook, uncertainty surrounding the outlook for the real economy is very high, and the Committee needs, in my view, to preserve flexibility to deal with unanticipated developments. Thank you, Mr. Chairman. " FOMC20080805meeting--115 113,MS. YELLEN.," Thank you, Mr. Chairman. Developments during the intermeeting period have heightened my concern about downside risks to economic growth and slightly allayed my concern about upside risks to inflation. Let me begin with growth. The moderate growth rate registered in the second quarter was disappointing, especially because it benefited from the temporary effects of the fiscal stimulus package. Moreover, the pattern of consumer spending during the quarter, with weakness in June, is worrisome. With all the publicity surrounding the rebate checks, households may have put them to work earlier than usual, especially since they were facing significantly higher prices for food and gasoline. This interpretation does not bode well for activity in the current quarter. Assuming no change in the funds rate this year, we have lowered our forecast for real GDP growth for the second half of the year about percentage point, to just � percent, and project a correspondingly higher unemployment rate. Our forecast for weak second-half growth reflects not only the unwinding of fiscal stimulus but also adverse financial sector developments. The credit crunch appears to have intensified since we last met. Evidence of tighter financial conditions abound. Risk spreads and the interest rates charged on a variety of private loans, including mortgages, are up noticeably, and lending standards have tightened further. Credit losses have risen not only on mortgages but also on auto loans, credit cards, and home equity lines of credit. As a consequence, the list of troubled depository institutions is growing longer. IndyMac and First National will not be the last banks in our region to fail. Indeed, the decline in broad stock market indexes is partly a reflection of the market's concerns about the health of the financial sector. Many financial institutions are deleveraging their balance sheets and reducing loan originations. For example, a large bank in my District has begun now in earnest to cancel or cap outstanding home equity loans and lines of credit, despite an ongoing concern about alienating consumers. Tighter credit is affecting demand. Anecdotal reports suggest that the plunge in July car sales partly reflects a tightening of credit standards for auto loans and leases. A large bank reports a substantial drop in demand for mortgage credit in response to the recent rise in mortgage interest rates, and the anecdotal reports that we hear support the Greenbook's negative view of the effect of credit conditions on investment in nonresidential structures. The housing sector is of considerable concern. House prices have continued to fall at a rapid rate, and futures prices suggest a further decline of around 10 percent over the next 12 months. This forecast seems reasonable given the overhang of homes for sale, the recent rise in mortgage rates, and the tightening of credit. Unfortunately, the risk of an adverse feedback loop from tighter credit to higher unemployment, to rising foreclosures, to escalating financial sector losses, to yet tighter credit remains alive and well, in my opinion. Indeed, stress tests conducted by some of the large financial institutions in our District reveal an exceptionally high sensitivity of credit losses to both home-price movements and unemployment. The ""severe financial stress"" simulation in the Greenbook illustrates my concern. It is not my modal forecast, but it certainly seems well within a reasonable range of outcomes. The probability of such a scenario has risen, in my view, since we met in June. One partially mitigating factor that should help to support consumer spending is the drop in the price of oil since our last meeting. But to the extent that the decline in oil prices partly reflects reduced expectations for global growth, the net impetus from stronger domestic spending will be offset by weaker export growth. Continued declines or even stabilization in oil prices will, however, be good for inflation. We have revised down slightly our forecast for core inflation as a consequence. Moreover, the fact that we were not once again surprised on the upside by oil prices has had a small favorable effect on my perception of inflation risks going forward. That said, inflation risks obviously remain. Even with the recent decline, energy prices are well above year-ago levels and are not only pushing up headline inflation but also spilling, to some extent, into core. Higher headline inflation could undermine our credibility and raise inflation expectations. If the public concludes that our implicit inflation objective has drifted up, workers may demand higher compensation, setting off a wage�price dynamic that would be costly to unwind. Fortunately, the reports I hear are consistent with the view that no such dynamic has taken hold. My contacts uniformly report that they see no signs of wage pressures. They note that high unemployment is suppressing wage gains. Growth in our two broad measures of labor compensation are low and stable; and taking productivity growth into account, unit labor costs have risen only modestly. I tend to think of the chain of causation in a wage�price spiral running from wages to prices, but it is certainly possible that the causation also, or instead, runs in the opposite direction. Either way, though, faster wage growth is an inherent part of the process by which underlying inflation drifts up, and at present we see not the slightest inkling of emerging wage pressures. Growth in unit labor costs also remains at exceptionally low levels. I would also note that I have looked for evidence of some increase in the NAIRU due to sectoral reallocation by examining the Beveridge curve, thinking that if there were sectoral reallocation we might see an outward shift in the Beveridge curve. I have detected no evidence of such an outward shift. These facts provide me with some comfort. Moreover, various measures of longer-term inflation expectations suggest that they remain relatively well contained. When we met in June, the Michigan survey of inflation expectations five to ten years ahead had recently jumped a couple tenths of a percentage point. I argued then that the respondents to that survey typically overrespond to contemporaneous headline inflation. Since that meeting, oil prices have come down a bit, and so have the Michigan survey measures. Assuming that the funds rate is raised from 2 percent to 3 percent in 2009, my forecast shows both headline and core PCE inflation falling to about 2 percent in that year. So, in summary, during the intermeeting period, my forecast for economic growth has weakened, and that for inflation has edged down slightly. I consider the risks to our two policy objectives pretty evenly balanced at the present time. " CHRG-110shrg46629--45 Chairman Bernanke," No, I think the market will find solutions. They already are finding some. For example, even if the individual instruments are not particularly liquid, there are indices that are based on the payments from CDOs or CLOs which are traded and therefore give some sense of the market valuation of these underlying assets. So this is a market innovation. Sometimes there are bumps associated with a market innovation. I think we just have to sit and see how it works out. There are very strong incentives in the market to change the structure of these instruments as needed to make them attractive to investors. Senator Reed. Let me change gears just slightly. You alluded to it, not the CDOs but the CLOs, the collateralized loan obligations, essentially derivatives of corporate debt. There has been a lot of discussion that it is very easy now to go out in this market and to prop up companies that do not have the ability to borrow directly. And that the underwriting standards have slipped a bit because the banks who typically do the underwriting do not hold the product. They move them out very quickly in these complex secondary markets. First, can you comment on the underwriting standards for the corporate borrowing? Are they loosening to a degree that could-- " FOMC20080430meeting--112 110,MR. KOHN.," Thank you, Mr. Chairman. My forecasts of output and inflation for this and the next two years are in the central tendencies of the Committee forecasts. My Okun's law machine went haywire under the pressure of Debbie's deadline, [laughter] so my unemployment forecasts need to be revised. But I hit the 5:00 deadline, I think. I have stronger growth in 2008 than the Greenbook because I was hesitant to adopt the staff's assumption about persistent, serially correlated downside misses relative to fundamentals in consumption and investment implied by entering a recessionary period when we haven't seen those misses yet. But I didn't discount this possibility entirely, reasoning that the extraordinarily depressed business and household sentiment was significant. I came out between the Greenbook baseline and the ""nearterm upside risk"" alternative scenario. Despite slightly stronger growth than in the Greenbook, I have roughly the same headline and core inflation paths that are declining gradually through the next few years. I took some slight encouragement from recent better readings on core. I reasoned that flat commodity prices would reverse any recent tendency for inflation expectations to rise, and I anticipate that vacant housing units will continue to put downward pressure on rent increases. I have a couple of observations on the outlook. First, I think the expectation of improving financial conditions is critical to the favorable medium-term outcome for the economy that President Geithner was just talking about. We don't really know what the current state of overall financial conditions is and how spending is likely to respond to them. Directionally, I think we can say that the severe deterioration that was much in evidence around the time of the last meeting has stopped, as concerns about an even more generalized set of failures--the seizing up of markets and lending--have abated with our actions and with successful capital-raising by intermediaries. We have seen improvements in many segments of the markets, but continued deterioration in term funding suggests to me that there are continued worries about and pressures on credit availability, and credit availability and the cost of credit will be under some pressure as credit is re-intermediated through the banks. Even with some of the recent gains, markets are still fragile and impaired. Spreads have retraced only a small portion of the run-up since last summer. I noticed in Bill's charts that most of those spreads are back down to, say, those in January; and in January, we thought the markets were pretty impaired. So they are still very, very high by historical standards. Mortgage securitization markets away from GSEs remain broken. There are problems in some other securitization markets, including CMBS. A number of intermediate- and longer-term interest rates are still higher than they were before the crisis hit in August. Baa corporate bonds, which is about the median borrower rating for a corporation, long-term muni bonds, and prime jumbo mortgages are all higher than before we did any easing. Nonprice terms and standards are being tightened considerably, judging in part from the Senior Loan Officer Opinion Survey, and I think that process is likely to continue for a while. To be sure, short-term interest rates are a lot lower than they were in August. But I suspect that a continuation of current conditions would not be consistent with much of a pickup in growth and an eventual return toward full employment. This is a circumstance in which relationships between the federal funds rate and other measures of financial conditions have changed very, very substantially, and characterizing the stance of policy and financial conditions by looking at some measure of the real federal funds rate can be quite misleading in these circumstances. I think we need to be careful about how we characterize and think about the stance of policy. The sense that it is neutral right now, much less accommodative, depends very much on our expectations of substantial increases in risk-taking in financial markets. Now, I do think that the most likely path is improving financial market conditions, lower spreads, reopened securitization markets, and stabilization and maybe partial reversal of some of the tighter terms that have evolved. But this process is going to be slow. Until the housing market shows more signs of stabilizing, it is more likely to be subject to backsliding than to sudden unexpected improvements. A corollary to this line of thinking is that there isn't a lot of ease in the pipeline in the conventional sense. Our reductions in the fed funds rate have not eased financial conditions. They have kept them from tightening even more than they would have done otherwise. The lagged effects of policy easing come from improvements in financial markets. That is, as we look forward, the lagged effects of policy easing come from the improvements in financial markets that allow the reductions in the actual and expected paths of short-term rates to show through to the cost of capital more broadly defined. This is a longer and more nuanced process than the usual rules of thumb about seeing the effects of ease on output after X quarters and inflation after Y quarters. My second point about the outlook is that the risks around my forecast for growth are still to the downside. Uncertainty is huge. We are sailing in a fog in uncharted waters, and the depth finder is on the fritz. So much for sailing analogies. [Laughter] Too bad Bill Poole is not here, though I am glad Jim is here. Let me note that for the record. [Laughter] Downside risks from financial market meltdown have been reduced, though not eliminated. But I think an important source of downside risk now is the economy itself--the threat of recessionary tendencies taking hold. I am told we have never had three months of substantial employment declines and business and household sentiment as depressed as they are right now without sliding into a recession. Businesses and households have been unusually cautious in how they invest their savings, moving into government-only money funds and bank deposits, boosting M2, and demanding much larger compensation for taking risks. They are facing much tighter terms for their credit and uncertainty about its availability. It seems to me there is a reasonable possibility that this extraordinary caution in managing their financial portfolios and uncertainty about credit availability will carry over into their spending decisions. That is not my projection or apparently the central tendency of the Committee, but it must be a significant downside risk. In contrast, the risk to total inflation seems skewed to the upside by the potential behavior of commodity prices. I don't understand why these prices have risen so much over the last six months or so. To be sure, over the last several years the rise in prices must have reflected increasing demand in emerging-market economies, but over the past half-year the prospects for global growth have weakened. In those circumstances, I would expect the effects of lower interest rates--say, in the United States--to be offset by weaker demand. Still, prices have risen. The possibility that those types of surprises will continue poses an upside risk to headline inflation and, along with that, a risk to inflation expectations. Nonetheless, I saw the risk around a gradual downtrend in core inflation as about balanced, with the possibility of greater slack offsetting the possibility of higher commodity prices. I take some comfort in my projection for core inflation and implicitly for the more persistent aspects of overall inflation from the continued moderate increases in labor compensation. Those increases have been moderate for some time despite very high headline inflation for several years along with still-elevated markups for nonfinancial businesses. Outside of commodities, cost pressures appear to be muted, and businesses are able to absorb increases. Still, I agree that commodity price increases, like any supply shock, have complicated our choices. We are facing a sluggish economy with downside risks as well as uncomfortably high total inflation that is feeding through to some limited extent into core inflation and, by some measures, into inflation expectations, especially near-term expectations. I do think, however, that we need to keep in mind that the higher inflation is largely a function of these commodity prices rather than a broad acceleration in overall prices. Core inflation has come in less than we anticipated it would. I also take some comfort, relative to some of the tone I have heard around the table, in what has happened in markets over the intermeeting period. Markets have built in another � point decline in the fed funds rate but then an increase further out. So somehow they are taking this promise of an increase seriously. At the same time they did that, the dollar rose--it didn't fall--and the long-term inflation compensation built into markets came down. So I don't see the evidence in financial markets that we are on the cusp of the broad decline in our credibility that I have sensed that some others see around the table. Thank you, Mr. Chairman. " CHRG-111hhrg48868--62 Mr. Clark," Thank you, Mr. Chairman, Ranking Member Garrett, and members of the subcommittee. Good morning. My name is Rodney Clark. I serve as a managing director in Standard & Poor's rating services business and from 2005 until very recently, I served as S&P's lead rating analyst covering AIG. I am pleased to appear before you today. Let me begin by speaking generally about our ratings process and the nature of our credit ratings. S&P's credit ratings are current opinions on the future credit risk of an entity or debt obligation. Our ratings do not speak to the market value of a security or the volatility of its price and they are not recommendations to buy, sell or hold a security. They are one tool for investors to use as they assess risk and differentiate credit quality of issuers and the debt that they issue. S&P analysts gather information about a particular issuer or debt issue, analyze the information according to our published criteria, form opinions and then present their findings to a committee of experienced analysts that votes on what ratings to assign. S&P publishes its ratings opinion in real time and for free on our Web site and we also generally publish a narrative that provides additional information about our opinion. This is the process by which S&P arrived at its ratings on AIG, which I will now discuss in more detail. Attached to my written submission is a table listing our global ratings history of AIG since 1990, as well as a more detailed description of our rationale for our rating changes. For many years, S&P had a triple A rating on AIG. Our opinion began to change in 2004 and since March 2005, we have lowered our ratings on AIG 4 times. In February of last year, S&P announced a negative outlook on the company's ratings related to the way AIG was determining the fair value of credit default swap contracts or CDS. AIG's CDS guaranteed an array of structured finance securities. Several months later, in May 2008, we lowered AIG's rating to double A minus following the company's announcement of further losses in their CDS portfolio and we maintained a negative outlook on AIG throughout the summer of 2008. In August, S&P announced that its view of the actual expected credit losses in the CDS area would likely amount to around $8 billion, significantly higher than the mark-to-market losses. AIG's financial condition continued to deteriorate sharply amid the substantial market turbulence in September 2008 leading to a sudden drop in the market value of AIG's investments and its CDS portfolio. In light of these events, on September 12, 2008, S&P placed its ratings on AIG and its subsidiaries on credit watch with negative implications. On September 15, 2008, as AIG's condition continued to deteriorate, S&P lowered its rating further to A minus in light of the increase in CDS related losses and AIG's reduced flexibility in meeting its collateral needs. Since then, AIG has benefitted from government support. Our rating on AIG remains at A minus, but includes a six notch uplift for the government support. Thus, without government support, our rating on AIG today would be double B minus. S&P recently affirmed its A minus rating on AIG; however, we maintain a negative outlook on the company's rating going forward. I have also been asked to address the effect of AIG's troubles on creditworthiness of its insurance subsidiaries. We believe those subsidiaries are, to some extent, protected by insurance regulations from AIG's financial problems. Nevertheless, we believe there is increased reputational risk for the subsidiaries at this time, which may eventually affect their earnings. Moreover, they may have reduced access to capital in the event AIG's condition should worsen. I have also been asked to address whether S&P's ratings may have contributed to the decline of AIG. We believe that AIG's difficulties resulted from the convergence of many factors, including the unprecedented and substantial deterioration in the market value of AIG's CDS portfolio. While some have argued that S&P's downgrade was too slow, others have said that we acted too aggressively and that our downgrades contributed to AIG's decline. We would not refrain from taking any rating actions simply out of deference to a particular issuer or at the request of a market participant. Our ratings are not driven by market sentiment; rather, our role to act as an independent observer offering our views on creditworthiness. Finally, you have asked me to describe any involvement S&P may have had in connection with the structuring or restructuring of the government support packages to AIG. Although S&P has been informed by government officials about the actions that have been taken, we have had no participation in the structuring or restructuring of these packages, nor has S&P provided or been asked to provide any advice or consultation to the government in connection with its support of AIG. I think you for the opportunity to participate in this hearing and I would be happy to answer any questions you have. [The prepared statement of Mr. Clark can be found on page 148 of the appendix.] " CHRG-111hhrg53238--220 Mr. Manzullo," Mr. Chairman, you know it is amazing, if I had asked each of you guys--that of course includes the gentlelady--what caused everything, the answer is pretty simple: too easy credit. The Federal Reserve had the authority to stop the 2/28 and the 3/27 mortgages, and the Federal Reserve also had the authority to require, goodness gracious, written proof of a person's income before that person was eligible to get the mortgage. You know something? No one starts with the problem. The problem is not in the derivatives, the problem is in the stinky piece of financial garbage that was generated because of the bad subprime loans. So if we already have a government agency that had the powers to stop this, and didn't do so for any number of reasons, why create another agency given the authority to come in and mess up? I mean, I don't know if you guys have taken a look at this Consumer Financial Protection Agency Act of 2009, the proposal on it. You know what that does? That says that this new organization gets to work with HUD, and perhaps FHSA, on a Truth-in-Lending and RESPA financial disclosure form. And how long did we fight those people at HUD on RESPA? When I chaired the Small Business Committee, that went on for 6 years. They finally came up with something they thought would work. And now FHA says well, we are going to take care of the appraisers. It allows banks to own an appraisal management company so that the appraisal management company can be wholly owned by the bank. But if you separate the men's bathroom from the women's bathroom, they can go out there and do an independent appraisal. And if a person gets an appraisal that he doesn't like--you know, we were told by the head of the FHFA what his resolution is: to contact them or the CC. You know, the more power and the more agencies we set up, it just screws everything up. I mean, Mr. Menzies, you know, you are a community banker. In your opinion--I like to pick on you--this is the third time since you have been here. In your opinion, if we did not have those exotic mortgages, if they were not allowed, and people had to show proof of their income, don't you agree that this crisis probably never would have occurred? " CHRG-110hhrg46596--25 Mr. Bachus," And I compliment you, Mr. Garrett, for your, I think, very constructive role. It has now been a little over 2 months since Congress passed legislation establishing TARP. A lot has happened in that time, some good and some bad. A particular concern of many members on this committee has been the Treasurer's ever-shifting strategies and explanations for its actions in implementing TARP, which have resulted in uncertainty among market participants and confusion among the American people. This has made it more difficult to achieve the goals that Congress has set in creating TARP and stabilizing the financial markets and increasing the flow of credit to Main Street. There has been some semblance of order restored in certain segments of the credit markets and among the financial service industry, and that is a good thing. No one faults Treasury for trying to tailor its policy responses to changing market conditions and challenges. But as the GAO report clearly states, implementing its various initiatives, Treasury has often failed to explain to Congress and the public what it hoped to achieve or to clearly communicate its expectations for the institutions that receive funding. For example, Treasury and the regulators have indicated recently that they expect the banks that have received an infusion of government money under the Capital Purchase Program to lend, rather than hoard, the cash. But the time to have thought about that, about what we expected banks to do with those funds, was before the money went out the door as a condition of investment rather than after the money was already in the banks' vault. That is why some of us in the negotiations on TARP asked if there would be conditions, and we were told that would limit the program. We talked about clawbacks, we talked about restrictions on dividends, we talked about something that Mr. LaTourette has complained about, and that is these banks using those funds to acquire their competitors or other banks. We think that is a serious matter. It is not in the legislation. But if there is any way to undo that admission, it needs to be done. Now I will close with this. I wonder whether Secretary Paulson or Mr. Kashkari, back when they were still working for Goldman Sachs, ever agreed to a deal in which billions of dollars changed hands, based on a 2-page application, without asking what the money was going to be used for or whether it was going to be paid back. For instance, the Uniform Residential Mortgage Application is 8 pages. The application for Federal Student Aid is 11 pages. When student lenders and mortgage companies ask more questions in lending thousands of dollars than the Federal Government does when it injects billions of dollars' worth of capital, we should all be concerned. The application process for the Capital Purchase Program, consisting of a 2-page form in which the bank identifies itself as a bank and asks for money and little else is very surprising. Secretary Paulson and Mr. Kashkari, you cannot be faulted for not having all the answers and for not being able to predict the future. But when you are acting on behalf of the American taxpayer, the taxpayer has the right to expect they will exercise the same basic judgment, the same standard of care that they would have exercised when they were working for Goldman Sachs and its investors. They should be held to the standard of care that we would expect from a reasonable, prudent investment banker whom I hope would not agree to a deal without doing some minimal amount of due diligence and conditions. Secretary Paulson and Mr. Kashkari should learn something from what we have seen in these past few weeks in connection with the committee's consideration of a possible bailout for the domestic auto industry. The CEOs of those automobile makers appeared before us to present detailed business plans showing how they intended to return their companies to profitability. They tried to justify their pleas for taxpayer help by admitting that their business models were flawed and explaining how they are going to change them. While the jury is still out on whether they made their case successfully, the detailed explanations and documents they put before us and the American people stand in stark contrast to the lack of information we have received from Treasury or from the financial institutions that have received taxpayer money under TARP. Let me close by thanking Chairman Frank for holding today's hearing, giving me the opportunity to focus on yesterday's hearing before the Oversight and Government Reform Committee, which was very important, and for inviting our colleague, the gentleman from Texas, Mr. Hensarling, to testify on the important work being done by the TARP Congressional Oversight Panel. He has some concerns. I share those concerns, and I look forward to his testimony. I look forward to his insights and those of the other witnesses. Thank you. " CHRG-111shrg57923--4 Mr. Tarullo," Well, Senator, I think that one of the lessons that the international community drew from some of the sovereign debt crises of the late 1990s and the very early years of this century was that there needed to be more transparency associated with a lot of sovereign debt issuance. And the International Monetary Fund undertook to create special data dissemination standards which would provide more such information. Generally speaking, I would distinguish between the sovereign information and private financial system firm information since we as regulators obviously have a mandate over private firms rather than certainly over sovereigns. It is relevant, though, for us in thinking about systemic risk because, to the degree that our large institutions have significant exposures to sovereigns which may conceivably have difficulty in servicing their debt, that becomes a matter of concern for the private financial regulators as well. Senator Reed. One of the issues that repeatedly is made--points, rather than issues--is that, you know, too big to fail is the first chapter, but the second chapter is too interconnected to fail. And that raises the issue of a focal point on large institutions might miss small institutions that could cause systemic risk. In fact, you know, there is the possibility that multiple failures in small institutions could have a systemic problem. So how do we sort of deal with that in terms of these interconnections? I mean, traditionally, it is easy for us to go to a big financial institution and say report X, Y, and Z. " FOMC20080625meeting--96 94,MR. KROSZNER.," Thanks a lot. Well, as I've mentioned many times before, I have thought about this as sort of a long, slow burn scenario; and as we well know, the embers are still smoldering. It seems to be less of a risk that they could re-ignite, causing a major conflagration; but there is still some chance of re-ignition, and I think there's still a fair amount of heat. Consistent with that, my central tendency view is probably closer to the Greenbook's ""delayed credit recovery"" alternative scenario than to the main Greenbook forecast. In looking at the alternative scenario, there's not much of a real effect on growth, but that response is due to a lower fed funds path. Given the discussions that we've had, I think it may be very difficult to pursue something like that in this environment, particularly given higher uncertainty about inflation and inflation expectations, even if, as a number of people have mentioned, inflation expectations haven't moved up that much or you pick your favorite measure and some have moved up more than others. Given that it's likely that we had some transitory factors keeping core and headline inflation down a little lower than they otherwise might have been and they probably are going to go up, I think that dealing with the ""delayed credit recovery"" alternative scenario in the way that's discussed in the Greenbook makes our policy choices particularly difficult. So let me focus briefly on why I think the delayed credit recovery or slow burn scenario is a reasonable central tendency one. I think it relates largely to our continuing challenges on banks' balance sheets, liquidity, and capital. Banks are facing very high short-term financing costs. Those LIBOR�OIS spreads are still at extremely elevated levels compared with what they're used to in funding themselves, and this is true whether they are commercial banks or investment banks. The forwards suggest that this ain't going away anytime soon. So one thing that this does is simply to cut into profitability and the ability to earn your way out of the challenges. An easy way to do it-- of just allowing the machine to go forward--is going to produce less than it otherwise would. A lot of institutions rely on the Federal Home Loan Banks, but those are largely tapped out as another source of financing. We know that the monoline issue has sort of come back, and the challenges there are great. It is undoubtedly going to be leading to a lot more write-downs over the next couple of quarters. On the other hand, as President Lockhart, Governor Warsh, and some others have mentioned, there have been a few areas that seem to have opened up. The leveraged-loan market seems to have opened up a bit. People seem to be getting those leveraged loans off their books-- and not even at effectively subsidized financing rates. They were proud of getting these off their books before, but they were doing it by basically just making another loan, which effectively doesn't get them off the books. Now it seems as though they are legitimately able to move this, and obviously that book is not growing. That book is shrinking. Of course, one of the biggest challenges is in housing, and I see the shocks of some of the resets from the nontraditional mortgages continuing through '09. We're seeing very significant increases in delinquencies and foreclosures, not only in the subprime space but also in the adjustable rate space generally--that's both subprime and prime, although the levels for prime are dramatically lower. The increases are quite significant for prime ARMs, and that starts to raise some challenges for the institutions that didn't do subprime but may still have a reasonable amount of prime ARMs on their books. HELOCs have been mentioned and the inability to securitize anything that's nonconforming. We've seen very little benefit yet from the changes that allow Freddie Mac and Fannie Mae to raise those limits. Also, as many of you know, from my visits around the country to your Districts, I see that conditions in different areas are dramatically different, but in general a lot of markets remain in very difficult circumstances. One of the largest mortgage lenders in the country said that, over the last couple of months, their average FICO score on what they've been originating outside the conforming market has been 800. That's astonishingly high--so that gets back to President Yellen's comment about even with FICO scores in the stratosphere--and they claim that's an average FICO score, and they have been pulling back on the HELOCs et cetera. On rising delinquency rates for credit cards, I didn't hear quite as bleak a view as Governor Warsh described. I wouldn't want to say a positive view. They seemed to say that it is where they would have expected it to be in this part of a cycle with increasing delinquencies. One thing that they were seeing was a little increase in payments, and so that may be one of the consequences of the stimulus check coming--that people are using it to pay down some of their credit card debt. But a big challenge that they have been seeing is the so-called roll rates--that once someone begins to go delinquent, they tend to roll right to full loss rather than getting some recovery. It suggests that, when people get into trouble, they are in fairly deep trouble. All of this means that the demand for capital is going to be very high going forward at these institutions as provisioning has to go up. You know, we've tapped sovereign wealth funds, institutional investors, and a lot of others. As Governor Warsh said, tapping other sources, encouraging perhaps private equity to come in, is something that's important. But how long are these guys willing to invest when over the past nine months every single investment has seen a reduction rather than an increase in value? I'm borrowing a prop from President Fisher--we have been going around and saying, ""Raise capital. You're worth it."" [Laughter] I hope the investment banks are going around to their shareholders and saying that also. So far there's not a lot of evidence that they have been. I think in the long run they will, but we have to worry about that. This slow burn scenario is even more problematic in the context of what Vice Chairman Geithner mentioned about some slowing of foreign demand that I think may be coming and in the context of a fair amount of increases in interest rates that may be coming in a lot of these countries. You're going to be seeing some credit tightening globally, as I think a number of people have mentioned. It is more likely, unless there's a major shock, to be more on the tightening side going forward. This makes it more difficult to deal with some of the issues in the ""higher inflation expectations"" alternative scenario that was in the Greenbook because, when you have this financial fragility, it's harder perhaps to raise interest rates as quickly or as much as you would like because of the concerns about what might happen in the financial markets. On inflation, I think much like President Stern and a number of others--it depends on which particular series you look at. It is hard to say that things have really become unmoored, but I think there's a lot more uncertainty in the minds of both the public and the market participants about where inflation may go. That's particularly problematic when you have the likely increase in the actual numbers coming that the Greenbook is forecasting for the next quarter or so; and in that context, dealing with some of the challenges is more difficult. But we'll talk about that more tomorrow. On the projections, I think it is important that we continue to increase transparency over time. We structured what we did last time to make it part of a process, and I think it makes sense to periodically revisit whether we want to continue on that road. I very much prefer a gradualist approach, in principle, to add year 5 or so--as the Chairman said--but I think there's a bit of a problem in doing that because too much meaning may be attributed to it. It may be too difficult to avoid saying, ""Well, we're just doing a target."" If we add year 4 and year 5, even though there's not a lot of information content in year 4, I think it helps to reduce the kind of shock value of seeing that fifth year out there. Now, that's potentially a negative because, in some sense, we want to provide more information that way. But given the fragile conditions, as Vice Chairman Geithner mentioned, I don't think that we want to generate a debate on inflation targets, employment targets, and other things like that particularly right now. So maybe having a gradualist approach, by which we just extend things to year 4 and year 5, which is seen as a natural outgrowth, wouldn't be as much of a shock. Not that I think it would be shocking, but I think it might raise as many concerns and as much of a debate and distract us from the key issues that we have before us. Thank you. " CHRG-111shrg50815--30 Mr. Plunkett," Thank you, Chairman Dodd, members of the Committee. I am Travis Plunkett, the Legislative Director at the Consumer Federation of America. I am testifying today on behalf of CFA and five other national consumer organizations. I appreciate the opportunity to offer our analysis of the very serious national consequences that unfair and deceptive credit card practices are having on many families in this recession as well as what this Committee can do to stop these traps and tricks. American families cannot become the engine of economic recovery if they are burdened by high credit card debt that can further escalate at a creditor's whim. I would like to summarize five points that I will leave with the Committee and then come back at the end of my testimony and provide a little detail on each point. First, the number of families in trouble with their credit card loans is approaching historic highs, as Senator Dodd said. Based on loss trends the card issuers are reporting, 2009 could be one of the worst years on record for credit card consumers. Second point, credit card issuers share a great deal of responsibility for putting so many Americans in such a vulnerable financial position through their reckless extension of credit over a number of years and use of abusive and unjustified pricing practices, which seem to be accelerating at this time when consumers can least afford it. Third, the need for quick action to end abusive lending practices is more urgent than ever now because taxpayers are propping up major credit card issuers through several enormously expensive programs. If the government is going to attempt to spur credit card issuers to offer more credit, it must ensure that the loans they are offering now are fair and sustainable. Fourth, the recent credit card rule finalized by the Federal regulators is a good first step in curbing abusive practices. It does have significant gaps, though, and as we have heard, it doesn't take effect until July of 2010. Fifth, Senator Dodd's comprehensive Credit Card Act fills in many of these gaps, as do a number of other legislative proposals that have been offered by members of this Committee. It will make the credit card marketplace fairer, more competitive, and more transparent. So let us talk a little detail here. On loss trends, Senator Dodd went through some of the most worrisome factors. One thing to watch is something industry insiders look at a lot. It is called the payoff rate. This is the amount of money that credit card consumers pay on their credit card bill every month and it has just dropped at the end of last year precipitously for credit cards. It is now at one of the lowest levels ever reported, showing that cardholders are having a harder time affording their bills and that the amount of money they can pay every month is dropping. Charge-offs and delinquencies--charge-offs is the amount of money proportionate to how much is loaned that credit card issuers write off as uncollectible--it is looking like they may approach the highest levels ever by the end of this year, and they are already quite high and have shot up very fast. Personal bankruptcy is up by about a third. On the responsibility that issuers have for this problem, just so you don't think this is last year's news or old news, let me just cite a few recent problems with some of the pricing practices you have heard about. They involve issuers adding new fees, increasing the amount of fees that they are charging, using harmful rather than responsible methods to lower credit lines, and a number of other abusive practices. Citigroup last fall back-pedaled on its promise to note increase interest rates any-time for any-reason, and then increased interest rates on a large part of their portfolio. Chase, as we have heard, has suddenly started charging people $120 a year for their accounts. These are cardholders who were promised a fixed rate for the life of their balance. Bank of America has used a variety of questionable methods for cardholders who appear to have done nothing wrong to violate their agreement, citing risk-based pricing and not providing clear information to these cardholders about the problem. Capital One and a number of other issuers over the last year, year and a half, have used very vague clauses in the cardholder agreements that allow them to increase interest rates for large parts of their portfolio for so-called market conditions. Let me be clear. Issuers do have the right to try and limit their losses in a recession, but these kinds of arbitrary and unjustified practices for cardholders who thought they were playing by the rules are very, very harmful. On the need for quick action because of government support, a couple of days ago, Treasury Secretary Geithner announced the expansion of a program that is supposed to provide taxpayer dollars to support securitization of credit card loans. They want more credit card lending. We have urged the Secretary to establish minimum fair practices standards for credit cards now so that our tax money isn't supporting unfair loans. On the Federal Reserve and regulator credit card rule, several positive aspects that we have heard about to the rule related to double-cycle billing, restrictions on increasing interest rates on existing balances, payment allocation. There are gaps, though. Fees are not addressed at all. Credit extension is not addressed at all. Bringing down rates if cardholders say they have a problem, then they pay on time for, say, 6 months, not addressed. And as we have heard, it doesn't take effect for a long time. The Credit Card Act and a number of other bills introduced in the Senate address many of these gaps. No any-time, any-reason repricing. That is the excuse Chase used. Limiting unjustified penalty fees by requiring that fees be reasonably related to the cost issuers incur, a very important part of the Credit Card Act. Limiting aggressive marketing and irresponsible lending to young consumers and lowering rates if consumers perform well after a problem occurs. Let me just close by saying that we have heard a lot about fears that fair regulation of the credit card market will lead to less credit, will lead to people who need it not having access to credit, especially lower-income or minority consumers. I always get a little worried because this context, or the context for this discussion is to ignore what has happened through essentially self-regulation of the market. I mean, where are we now? Issuers have been able to write their own rules for a very long time and they are cutting back on credit, especially to more vulnerable borrowers, especially to lower-income and minority borrowers. Plus, we have to deal with the kind of uncompetitive, not transparent marketplace we have heard about. So it sounds like the worst of all possible worlds to me, and that is why we support Senator Dodd's bill and fair regulation of the marketplace. " CHRG-111hhrg56766--92 Mr. Bernanke," Well, we have been working on it very hard. We have, for example, increased substantially our information-gathering so that we can make an assessment of how many loans are turned down, what is the rate of loss on small loans versus large loans. We added questions to the National Federation of Independent Businesses Survey asking small firms about their experience with borrowing and so on. So we are trying very hard. We have also our reserve banks around the country currently having a series of summit meetings with community leaders, development organizations, small business lenders, and small companies to try to figure out what the problems are. So we are actively going out and learning about the situation the best we can. It's very difficult because there will be some cases where tighter standards are justified because of the weakness of the economy and the weakness of the borrower's condition. We just want to make sure that when there is a creditworthy borrower that they can obtain credit. " CHRG-111shrg56415--12 Mr. Candon," Honorable Chairman Johnson, Ranking Member Crapo, and members of the Subcommittee, thank you for the opportunity to testify. I am the Deputy Commissioner of Banking and Securities for the Vermont Department of Banking, Insurance, Securities, and Health Care Administration. I appear on behalf of the State Credit Union Regulators as Chairman of NASCUS. Today, I will share information on the conditions of State credit unions and areas for reform. Like all financial institutions, State credit unions have been adversely affected by the current economy. However, at this point, State natural person credit unions remain generally healthy and continue to serve the needs of their members and their communities. For the most part, natural person credit unions did not engage in many of the practices that precipitated the current market downturn. However, we have several issues to bring to your attention about the impact of the economy and the need for capital options for credit unions. State regulators remain concerned about unemployment and its effects on credit union members' ability to meet their obligations. We also see increases in delinquencies and charge-offs as well as pressure on earnings, especially in smaller State credit unions. Although loan delinquency and net charge-offs have increased, State regulators indicate that the levels remain manageable. In response to this trend, regulators are increasing their oversight of consumer credit products, including auto loans, credit cards, real estate and home equity loans. State regulators are also closely monitoring member business lending in credit unions. Some States, including my home State of Vermont, have not experienced the fallout from commercial real estate or subprime lending because State credit unions do not engage in those activities. State regulators continue to encourage credit unions to exercise sound underwriting practices, proper risk management, and due diligence, as these are the practices that have kept credit unions healthier through the economic downturn. In anticipation of prolonged economic problems, State regulators will closely monitor both lending and investment activities. State regulators also emphasize strong governance standards at the credit union board level. We will continue close supervision through offsite monitoring and onsite examinations and visitations. The growing trend toward consolidation is on the minds of State regulators as credit union mergers continue to occur, both voluntarily and for regulatory purposes. As economic pressures continue, finding suitable merger partners may become more difficult. In response to your question about capital needs, access to capital for credit unions is critical. Unlike other financial institutions, credit union access to capital is limited to reserves and retained earnings. State regulators recommend capital raising options for all credit unions. Access to supplemental capital will enable credit unions to respond proactively to changing market conditions, thereby strengthening safety and soundness and providing a buffer for the Credit Union's Share Insurance Fund. It is NASCUS's studied belief that a change to the Federal law could provide this valuable tool to credit unions without altering their nonprofit and cooperative structure. Supplemental capital will not be appropriate for every credit union nor would every credit union need access to supplemental capital. However, the option should be available. State regulators are also concerned about the impact of corporate credit union losses on natural person credit unions. Given the severity of the losses, it is clear that enhanced regulatory standards for capital, governance, and risk management are necessary. State regulators are working with the NCUA to ensure the safety and soundness of corporate credit unions and to mitigate future risk. Last, I would like to emphasize the value of the dual regulatory system. State regulators have demonstrated the importance of local supervision of State-chartered institutions and the value of the dual regulatory system. State regulators have always emphasized consumer protection along with safety and soundness as an important part of their mission and accountability to Governors and State legislatures. Further, State regulators have the expertise to identify areas of risk and take enforcement actions where necessary. As regulatory modernization efforts are considered by the Senate Banking Committee, we encourage you to retain State supervision and reaffirm State authority. NASCUS and State regulators appreciate the opportunity to testify today. I will be pleased to respond to any questions that you have. Thank you, Mr. Chairman. Senator Johnson. Thank you, Mr. Candon. Let us put 7 minutes on the clock for each member to ask questions of our witnesses. Ms. Bair, so far, 98 institutions have failed this year and the FDIC's watch list has grown to 416 institutions. How many more of the troubled institutions do you anticipate will fail? Is the FDIC staffed up to deal with an increase in failures? Ms. Bair. Mr. Chairman, thank you for asking that question. There will be more failures. We do not make our failure projections public, but failures will continue at a pretty good pace this year and next. We think we will have about $100 billion in losses over a 5-year period starting at the beginning of 2009. Twenty-five billion of that has already been realized from failures this year, and we have already reserved for another $32 billion as of the end of the second quarter. We are ready for this, though. We have been prepared for some time. We started staffing up in 2007, especially in our receivership and resolution staff, but also beefing up our examination staff. We have 6,300 staff on board now. That number will likely go to 7,000. We also have a significant roster of consultants that we use to help with bank closings as well as asset valuations, asset management, and asset marketing. The FDIC really is designed for this type of activity. We can expand very quickly and then contract very quickly. A lot of our hires are temporary 2-year hires. Overall, we have got a very good track record. These closings have been seamless. Through using loss share, we have been able to, more often than not, do a whole bank transaction. So another bank that serves that same community acquires both the deposits and the assets, which is good for bank customers. Frequently, the depositors are also the borrowers at the bank. Overall, it has been handled well. I think the staff have made a tremendous effort. We are well staffed and very much prepared for this. Senator Johnson. Governor Tarullo, there has been much concern raised that commercial real estate is the next problem area for financial institutions. What are the differences between the concerns over commercial real estate and the problems we experienced last year with mortgages? " FOMC20070918meeting--124 122,MR. KOHN.," Thank you, Mr. Chairman. The repricing of risk and rechanneling of credit flows under way I believe will exert restraint on spending, especially in the near term, but over the longer run as well. A critical channel of contagion that came into play in the intermeeting period was the involvement of the banks as providers of credit and liquidity backstops in the ABCP market. As a consequence, uncertainties about real estate markets, the performance of nonprime mortgages, and structured-credit products came to rest as greater uncertainty about bank exposures. The classic flight to safety under way—the desire to protect capital and liquidity—has caused banks and those providing them credit to become more cautious. This has resulted in greatly reduced funding in term markets spreading the constriction of credit potentially well beyond the mortgage and leveraged-loan markets we talked about in early August. Like so many around the table, I feel that I can honestly say that the uncertainties around the output forecast were indeed larger than usual this time. Fortunately, we don’t have many degrees of freedom to test hypotheses about the sorts of relationships that we’re talking about here. I think we can expect effects on spending to be greatest in the short and intermediate terms, while markets are disrupted and while participants are struggling to find new ways of intermediating credit that address the perceived shortcomings of the previous practices. In the short run, to preserve capital and liquidity while secondary markets are impaired, banks have tightened terms and standards for loans. You can see this directly in the rise in spreads in the prime jumbo market, but it must be true for other less easily observed credits as well. Some credits, such as nonprime mortgages and leveraged loans, just haven’t been available for a while. An already weak housing market has been most directly affected, and construction sales and prices will probably fall substantially further because of the reduced demand along with a large overhang of unsold homes. Consumption spending is also likely to be trimmed. Tighter terms for home equity lines of credit and second mortgages mean not only that housing wealth is declining but also that it is probably less liquid and more expensive. To the extent that asset- backed security markets are affected and lenders have questions about consumer balance sheets, the cost of consumer credit could well rise also. Household confidence has apparently been affected by the adverse financial market news. Investment spending may also be held down by uncertainty, by a sense that consumer demand will be growing less rapidly. I have been struck in listening to presidents around the table report about their Districts that the tone has shifted noticeably toward less optimism, slower growth, and more caution on the part of our business respondents. It has been one of those shifts that you hear every couple of years around the table that are different from what might have been anticipated, say, from reading the Beige Book. There is also some tightening of credit conditions in the business sector—for example, for commercial real estate credit, as some have noted, and for credit for below-investment-grade firms. As a consequence, some downshift in GDP is highly likely over the next few quarters, and without policy action, we would most likely end up with a substantially lower GDP a few quarters out. Indeed, in the Greenbook, the output gap is noticeably wider at the end of ’08 despite near-term policy easing of 50 basis points. I also noted downside risk to my output forecast. It seems to me that, in this period when markets are adjusting, those risks are most skewed. The potential for adverse interactions seems large, as nervous creditors assess the implications of declines in house prices, volatile earnings of commercial and investment banks, and setbacks in overall confidence. I think there is a non-negligible risk that the constrictions in credit availability would feed back on the economy and, in turn, feed back on credit supply. As market participants are better able to distinguish and assess risk, liquidity will be re-established in many markets. Although we have seen some improvement in the past week or two, markets are still quite dysfunctional in many regards. Like others, I think it could take a while to discover how to structure securitizations that have the requisite transparency and appropriate principal-agent incentives to restore investor confidence and to recalibrate the roles of securities markets and banks. The process could be particularly drawn out in mortgage and related markets, which are likely to be affected for some time by uncertainties about the prices of houses and about the performance of mortgages. Moreover, some effects of the recent turmoil will be longer lasting. Risk spreads in a great variety of markets are likely to be at higher, more- realistic, and more-sustainable levels; banks should be charging more for credit liquidity backstops; less leverage in the financial sector implies a need for return on the greater amount of capital involved in intermediation, including at banks; and some credit conditions at any given fed funds rate will be tighter one year from now than they were a few months ago. I have concentrated on problems for growth, but the upside inflation risks have not disappeared. Unit labor costs have been rising. Markups, while still high, have come in, affording a reduced cushion for absorbing labor costs. Resource utilization remains high by historical standards. Import prices may prove problematic. Although commodity prices may level out as in the staff forecast, foreign economies also are producing at high levels. Pressures on the costs of finished goods could increase, especially if the dollar declines further. My expectations for the most likely path for inflation have been revised just a tick lower, given the favorable incoming data and the lower path for economic activity relative to potential, which will increase competitive pressures in labor and product markets. For now, given this outlook, we need to concentrate on the potential effects of the disruptions to financial markets on the real economy when we consider policy in the next portion of this meeting. Thank you, Mr. Chairman." CHRG-111hhrg52261--89 Mr. Hirschmann," I think you are right to identify the scope of the proposed CFPA as one of the problems. There are a couple of other issues, including, it separates out consumer protection from safety and soundness regulation. So you might have one regulator telling you to go left and the other telling you to go right with no way to reconcile the differences. That clearly will impact the availability of credit, particularly for small firms. The other is the ill definition of all the terms. For example, it sets up a new, vaguely defined abuse standard. What our study reveals is that a product that might seem to be abusive for one individual consumer in a particular financial condition might be the lifeline for a small business to meet their payroll that week and perfectly appropriate for the small business. It is hard to imagine how a Federal regulator could anticipate those differences and make sure we don't accidentally cut off the vital lifeline for small businesses. " FOMC20080724confcall--144 142,MR. HOENIG.," I'm comfortable with 84. I'd be interested in thinking about the 28-day as well, but I'm comfortable with 84 as long as we have the conditions that I talked about. Thank you. " CHRG-111shrg382--18 Mr. Tarullo," Thank you, Senator. Let me reemphasize the premise of your question, which is that resolution is very much of a challenge. Let me step back for a second and suggest why it is such a challenge, even more than a lot of the other areas we are talking about. If we want to make changes in capital standards and the FSB gets together and we converge around a set of changes, we all have ample domestic legal authority under our own constitutional structures to go back and make those changes. In the area of resolution, of course, we are talking about bankruptcy law. We are talking about bank insolvency law under the FDI Act, things that the Congress and parliaments around the world have put into legislation. So here, each country has its own set of legal rights and priorities for creditors. We have our own set of laws on what constitutes a fraudulent conveyance, for example. We have our own set of practices as to what kinds of creditor adjustments can be made during a bankruptcy or resolution procedure. So, from some people's point of view, the first best or at least the cleanest solution would be one that would have to harmonize the bankruptcy and resolution mechanisms and laws all around the world---- Senator Shelby. And that is no easy task. " CHRG-111shrg57321--161 Mr. McDaniel," Thank you, Mr. Chairman and Senator Kaufman. I am Ray McDaniel, Chairman and CEO of Moody's Corporation, the parent of the credit rating agency Moody's Investor Service. I want to thank you for the opportunity to contribute Moody's views today.--------------------------------------------------------------------------- \1\ The joint prepared statement of Mr. McDaniel and Ms. Yoshizawa appears in the Appendix on page 186.--------------------------------------------------------------------------- The global financial crisis has sparked a necessary debate about the role and performance of numerous participants in the financial markets. With respect to credit rating agencies, many market observers have expressed concerns that ratings did not better predict the deteriorating conditions in the subprime mortgage market. Let me assure you that Moody's is not satisfied, and I am not satisfied, with the performance of our ratings during the unprecedented market downturn of the past 2 years. We did not anticipate the extraordinary confluence of forces that drove the unusually poor performance of subprime mortgages. We were not alone in this regard, but I believe that we should be at the leading edge for predictive opinions about credit risk. Some key issues influencing the unanticipated performance included the steep and sudden nationwide decline in home prices and the sharp contraction that followed in credit available from banks for mortgage refinancing. Moody's did observe a trend of loosening mortgage underwriting and escalating home prices. We highlighted that trend in our reports and incorporated it into our analysis of mortgage-backed securities. And, as conditions in the U.S. housing market began to deteriorate beyond our expectations, we took the rating actions that we believed at the time were appropriate based on the information we had. Let me summarize our actions during the 2003 to 2007 time frame. First, starting in 2003, we identified and began commenting on the loosening of underwriting standards and escalating housing prices through our sector publications. Second, we tightened our ratings criteria in response to these loosening standards. In fact, between 2003 and 2006, we steadily increased our loss expectations and the levels of credit protection required for a given rating level. In practical terms, this meant that by 2006, half the mortgages in a pool would have to default and provide a recovery of just half the appraised value of the home before a subprime RMBS bond rated AAA by Moody's would suffer its first dollar of loss. This is a level of anticipated loss that far exceeded the losses that actually occurred in the past four real estate recessions. But even these conservative assumptions proved insufficient. Third, we took steps to watch and analyze the unprecedented market conditions and the behavior of various market participants as the crisis continued to unfold. For example, one question before the market was how borrowers, servicers, and banks would respond to the resetting of mortgage interest rates and how that behavior would affect default rates. Faced with extraordinary conditions, we saw market participants, including borrowers, mortgage servicers, mortgage originators, and the Federal Government, behave in historically unprecedented ways. Fourth, we took rating actions when the mortgage performance data warranted. Moody's monitors the actual performance of the mortgages and the securities that we rate throughout the life of the security. The early performance of the 2006 loans was, in fact, comparable to the performance of similar subprime loans during the 2000 and 2001 recession. And not until performance data from the second quarter of 2007 was available did it become clear that many of the 2006 vintage bonds might perform worse than those from the prior recession. In short, Moody's did see the loosening of some prime lending standards. We reported our observations to the market and we incorporated our increasingly unfavorable views into the ratings we assigned. However, let me emphasize again that we, like most other market participants, did not anticipate the severity or the speed of deterioration that occurred in the U.S. housing market, nor did we anticipate the behavior of market participants in response to the housing downturn, including the speed of credit tightening by financial institutions that followed and exacerbated the situation. The unprecedented events of the last few years provide critical lessons to all market participants, certainly including us. At Moody's over the past 2 years, we have undertaken a wide range of initiatives to strengthen the quality, transparency, and independence of our ratings. Some of these measures include establishing common macroeconomic scenarios for rating committees, publishing volatility scores and sensitivity analysis on structured finance securities, consolidating surveillance activities and structured finance under one leadership, and further bolstering the independence of and resources for our credit policy function. Moody's is firmly committed to meeting the highest standards of integrity in our rating practices. We wholeheartedly support constructive reforms and we are eager to work with Congress, regulators, and other market participants to that end. I am happy to respond to your questions. Senator Levin. Thank you very much, Mr. McDaniel. Ms. Corbet. TESTIMONY OF KATHLEEN A. CORBET,\1\ FORMER PRESIDENT (2004- 2007), STANDARD AND POOR'S Ms. Corbet. Thank you, Mr. Chairman and Senator Kaufman.--------------------------------------------------------------------------- \1\ The prepared statement of Ms. Corbet appears in the Appendix on page 210.--------------------------------------------------------------------------- My name is Kathleen Corbet and my career spans over 25 years of experience within the financial services industry. For a 3-year period during my career, I served as President as Standard and Poor's, a division of the McGraw-Hill Companies, from April 2004 until my voluntary departure in September 2007. Before turning to the substantive issues raised by the Subcommittee's investigation, I would like to acknowledge the important work of the Subcommittee and Congress more broadly in its examination of the causes and consequences of the financial crisis. It is difficult not to feel personally touched by the pain experienced by many as a result of the turmoil in the subprime market and the financial crisis that followed. Many people feel anger, and in my view, that anger is understandable. Accordingly, I believe strongly that we should collectively use the lessons from this crisis to focus on effective reforms, stronger investor protections, better industry practices, and accountability. As background, I was recruited to join the McGraw-Hill Companies as an Executive Vice President of its Financial Services Division in April 2004 and served as President of Standard and Poor's until my successor, Deven Sharma, took over that position in September 2007. During my 3-year tenure, I led an organization of 8,000 employees based in 23 countries which provided financial information and market analysis to its customers and the broader market as a whole. The company was organized across four primary business units, including Rating Services, Equity Research Services, Index Services, and Data and Information Services. Each business unit was led by a seasoned executive having direct operating responsibility in the respective area and reporting directly to me. One of those units was Rating Services, which issued credit ratings on hundreds of thousands of securities across the globe, including corporate securities, government securities, and structured finance securities. Rating Services was led by an Executive Vice President for Ratings, an executive with over 30 years of experience in the ratings business, who had day-to-day operational responsibility for that business. Among her direct reports was the Executive Managing Director of Structured Finance Ratings, who was responsible for the day-to-day operations of the Structured Finance Ratings Group, the group that issued the ratings that are the subject of this Subcommittee's focus. Consistent with S&P's longstanding and publicly disclosed practice, ratings decisions were and are solely the province of committees comprised of experienced analysts in the relevant area. This practice is based on the principle that the highest quality analysis comes from the exercise of independent analytical judgment free from both undue external or internal pressure. Accordingly, during my tenure, I did not participate in any rating or analytical criteria committee meetings regarding ratings on any type of security, including mortgage-backed securities. All that said, I do hope to be able to provide a business perspective that is helpful to the Subcommittee, and in my view, it is clear that many of the ratings S&P issued on securities backed by subprime mortgages have performed extremely poorly. S&P has publicly stated its profound disappointment with that performance, and I deeply share that sentiment. From my personal perspective, I believe the primary reason for these downgrades is that, despite its efforts to get the rating right and despite rooting its analysis in historical data, S&P's assumptions did not capture the unprecedented and unexpected outcomes that later occurred with respect to the housing market, borrower behavior and credit correlations. S&P, along with others, has been criticized for its failure to predict what happened in the subprime market, and in many ways, that criticism is justifiable. Moreover, the subsequent outcome of the severe economic downturn and downgrades of securities backed by subprime mortgages highlight the challenges inherent in the nature of ratings. At their core, ratings are opinions about what may happen in the future, specifically, the likelihood that a particular security may default. I think that most people agree that predicting the future is always challenging and outcomes can often turn out very differently than even the most carefully derived predictions anticipate. The key from my perspective is to learn from these experiences and to take specific actions to improve. The credit rating industry has begun to respond in a constructive fashion, but there is much more to be done. Through the course of history and through many market cycles, the credit rating industry has played an important role in the financial system for nearly a century, and I do believe that it has the opportunity to continue to do so through the commitment to continual improvements and from appropriate regulatory reform. Again, I appreciate the goals of the Subcommittee's work and would be glad to answer any questions that you have. Senator Levin. Thank you, Ms. Corbet. Thank you both. Before we start with questions, let me put into the record a statement of the Attorney General of the State of Connecticut, Richard Blumenthal. He has made a very powerful statement about the topic of the hearing today, which is ``Wall Street and the Financial Crisis: The Role of Credit Rating Agencies,'' and that will be made part of the record at an appropriate place.\1\--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Blumenthal appears in the Appendix as Exhibit 109, on page 1201.--------------------------------------------------------------------------- Were you both here earlier? Ms. Corbet. Yes, I was. Senator Levin. Mr. McDaniel, were you here, too? " fcic_final_report_full--89 In , President Bill Clinton asked regulators to improve banks’ CRA perform- ance while responding to industry complaints that the regulatory review process for compliance was too burdensome and too subjective. In , the Fed, Office of Thrift Supervision (OTS), Office of the Comptroller of the Currency (OCC), and Federal Deposit Insurance Corporation (FDIC) issued regulations that shifted the regulatory focus from the efforts that banks made to comply with the CRA to their actual re- sults. Regulators and community advocates could now point to objective, observable numbers that measured banks’ compliance with the law. Former comptroller John Dugan told FCIC staff that the impact of the CRA had been lasting, because it encouraged banks to lend to people who in the past might not have had access to credit. He said, “There is a tremendous amount of investment that goes on in inner cities and other places to build things that are quite impressive. . . . And the bankers conversely say, ‘This is proven to be a business where we can make some money; not a lot, but when you factor that in plus the good will that we get from it, it kind of works.’”  Lawrence Lindsey, a former Fed governor who was responsible for the Fed’s Divi- sion of Consumer and Community Affairs, which oversees CRA enforcement, told the FCIC that improved enforcement had given the banks an incentive to invest in technology that would make lending to lower-income borrowers profitable by such means as creating credit scoring models customized to the market. Shadow banks not covered by the CRA would use these same credit scoring models, which could draw on now more substantial historical lending data for their estimates, to under- write loans. “We basically got a cycle going which particularly the shadow banking industry could, using recent historic data, show the default rates on this type of lend- ing were very, very low,” he said.  Indeed, default rates were low during the prosper- ous s, and regulators, bankers, and lenders in the shadow banking system took note of this success. SUBPRIME LENDERS IN TURMOIL: “ADVERSE MARKET CONDITIONS ” Among nonbank mortgage originators, the late s were a turning point. During the market disruption caused by the Russian debt crisis and the Long-Term Capital Management collapse, the markets saw a “flight to quality”—that is, a steep fall in de- mand among investors for risky assets, including subprime securitizations. The rate of subprime mortgage securitization dropped from . in  to . in . Meanwhile, subprime originators saw the interest rate at which they could borrow in credit markets skyrocket. They were caught in a squeeze: borrowing costs increased at the very moment that their revenue stream dried up.  And some were caught holding tranches of subprime securities that turned out to be worth far less than the value they had been assigned. Mortgage lenders that depended on liquidity and short-term funding had imme- diate problems. For example, Southern Pacific Funding (SFC), an Oregon-based sub- prime lender that securitized its loans, reported relatively positive second-quarter results in August . Then, in September, SFC notified investors about “recent ad- verse market conditions” in the securities markets and expressed concern about “the continued viability of securitization in the foreseeable future.”  A week later, SFC filed for bankruptcy protection. Several other nonbank subprime lenders that were also dependent on short-term financing from the capital markets also filed for bank- ruptcy in  and . In the two years following the Russian default crisis,  of the top  subprime lenders declared bankruptcy, ceased operations, or sold out to stronger firms.  CHRG-110shrg50420--334 Mr. Wagoner," We did consider an acquisition. I would say two things happened during the process. One, the market dropped dramatically so our own funding needs increased more than we thought, and so as we discussed that with the board, they said, boy, we had better make sure we have enough funding to take care of our own business. And as you know, any kind of merger-acquisition activity is pretty human resources intensive. Second of all, at the beginning of these conversations, there was a lot of discussion about public funding, be it public market funding being available. And as the credit market conditions deteriorated, that opportunity changed. And so as a result of that, the whole issue of focusing on the very important issue of liquidity for GM was, I think, appropriately at the top of the issue for our board. Senator Corker. Let me ask you this. The plan at the time, and I realize things have changed, it did say that there would be lesser outside money necessary, a pretty large amount, if the two of you all merged, did it or did it not? " FOMC20070321meeting--188 186,MR. POOLE.," The way I would look at the issue is to suppose that we have another break in the stock market of 5 percent or 8 percent, something like that. If we put “financial conditions” now, we clearly couldn’t put it in the next time if we had that condition. Then what would it mean for us to take it out? That’s why, among the other things that people have said, I would prefer not to have it in." CHRG-110shrg50409--111 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System July 15, 2008 Chairman Dodd, Senator Shelby, and Members of the Committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. The U.S. economy and financial system have confronted some significant challenges thus far in 2008. The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions. The effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities, which have sapped household purchasing power even as they have boosted inflation. Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year, while inflation has remained elevated. Following a significant reduction in its policy rate over the second half of 2007, the Federal Open Market Committee (FOMC) eased policy considerably further through the spring to counter actual and expected weakness in economic growth and to mitigate downside risks to economic activity. In addition, the Federal Reserve expanded some of the special liquidity programs that were established last year and implemented additional facilities to support the functioning of financial markets and foster financial stability. Although these policy actions have had positive effects, the economy continues to face numerous difficulties, including ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of oil, food, and some other commodities. Let me now turn to a more detailed discussion of some of these key issues. Developments in financial markets and their implications for the macroeconomic outlook have been a focus of monetary policymakers over the past year. In the second half of 2007, the deteriorating performance of subprime mortgages in the United States triggered turbulence in domestic and international financial markets as investors became markedly less willing to bear credit risks of any type. In the first quarter of 2008, reports of further losses and write-downs at financial institutions intensified investor concerns and resulted in further sharp reductions in market liquidity. By March, many dealers and other institutions, even those that had relied heavily on short-term secured financing, were facing much more stringent borrowing conditions. In mid-March, a major investment bank, The Bear Stearns Companies, Inc., was pushed to the brink of failure after suddenly losing access to short-term financing markets. The Federal Reserve judged that a disorderly failure of Bear Stearns would pose a serious threat to overall financial stability and would most likely have significant adverse implications for the U.S. economy. After discussions with the Securities and Exchange Commission and in consultation with the Treasury, we invoked emergency authorities to provide special financing to facilitate the acquisition of Bear Stearns by JPMorgan Chase & Co. In addition, the Federal Reserve used emergency authorities to establish two new facilities to provide backstop liquidity to primary dealers, with the goals of stabilizing financial conditions and increasing the availability of credit to the broader economy. \1\ We have also taken additional steps to address liquidity pressures in the banking system, including a further easing of the terms for bank borrowing at the discount window and increases in the amount of credit made available to banks through the Term Auction Facility. The FOMC also authorized expansions of its currency swap arrangements with the European Central Bank and the Swiss National Bank to facilitate increased dollar lending by those institutions to banks in their jurisdictions.--------------------------------------------------------------------------- \1\ Primary dealers are financial institutions that trade in U.S. government securities with the Federal Reserve Bank of New York. On behalf of the Federal Reserve System, the New York Fed's Open Market Desk engages in the trades to implement monetary policy.--------------------------------------------------------------------------- These steps to address liquidity pressures coupled with monetary easing seem to have been helpful in mitigating some market strains. During the second quarter, credit spreads generally narrowed, liquidity pressures ebbed, and a number of financial institutions raised new capital. However, as events in recent weeks have demonstrated, many financial markets and institutions remain under considerable stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain. In recent days, investors became particularly concerned about the financial condition of the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. In view of this development, and given the importance of these firms to the mortgage market, the Treasury announced a legislative proposal to bolster their capital, access to liquidity, and regulatory oversight. As a supplement to the Treasury's existing authority to lend to the GSEs and as a bridge to the time when the Congress decides how to proceed on these matters, the Board of Governors authorized the Federal Reserve Bank of New York to lend to Fannie Mae and Freddie Mac, should that become necessary. Any lending would be collateralized by U.S. government and Federal agency securities. In general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve. I turn now to current economic developments and prospects. The economy has continued to expand, but at a subdued pace. In the labor market, private payroll employment has declined this year, falling at an average pace of 94,000 jobs per month through June. Employment in the construction and manufacturing sectors has been particularly hard hit, although employment declines in a number of other sectors are evident as well. The unemployment rate has risen and now stands at 5\1/2\ percent. In the housing sector, activity continues to weaken. Although sales of existing homes have been about unchanged this year, sales of new homes have continued to fall, and inventories of unsold new homes remain high. In response, homebuilders continue to scale back the pace of housing starts. Home prices are falling, particularly in regions that experienced the largest price increases earlier this decade. The declines in home prices have contributed to the rising tide of foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in turn, intensified the downward pressure on home prices in some areas. Personal consumption expenditures have advanced at a modest pace so far this year, generally holding up somewhat better than might have been expected given the array of forces weighing on household finances and attitudes. In particular, with the labor market softening and consumer price inflation elevated, real earnings have been stagnant so far this year; declining values of equities and houses have taken their toll on household balance sheets; credit conditions have tightened; and indicators of consumer sentiment have fallen sharply. More positively, the fiscal stimulus package is providing some timely support to household incomes. Overall, consumption spending seems likely to be restrained over coming quarters. In the business sector, real outlays for equipment and software were about flat in the first quarter of the year, and construction of nonresidential structures slowed appreciably. In the second quarter, the available data suggest that business fixed investment appears to have expanded moderately. Nevertheless, surveys of capital spending plans indicate that firms remain concerned about the economic and financial environment, including sharply rising costs of inputs and indications of tightening credit, and they are likely to be cautious with spending in the second half of the year. However, strong export growth continues to be a significant boon to many U.S. companies. In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared economic projections covering the years 2008 through 2010. On balance, most FOMC participants expected that, over the remainder of this year, output would expand at a pace appreciably below its trend rate, primarily because of continued weakness in housing markets, elevated energy prices, and tight credit conditions. Growth is projected to pick up gradually over the next 2 years as residential construction bottoms out and begins a slow recovery and as credit conditions gradually improve. However, FOMC participants indicated that considerable uncertainty surrounded their outlook for economic growth and viewed the risks to their forecasts as skewed to the downside. Inflation has remained high, running at nearly a 3\1/2\ percent annual rate over the first 5 months of this year as measured by the price index for personal consumption expenditures. And, with gasoline and other consumer energy prices rising in recent weeks, inflation seems likely to move temporarily higher in the near term. The elevated level of overall consumer inflation largely reflects a continued sharp run-up in the prices of many commodities, especially oil but also certain crops and metals. \2\ The spot price of West Texas intermediate crude oil soared about 60 percent in 2007 and, thus far this year, has climbed an additional 50 percent or so. The price of oil currently stands at about five times its level toward the beginning of this decade. Our best judgment is that this surge in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets. Over the past several years, the world economy has expanded at its fastest pace in decades, leading to substantial increases in the demand for oil. Moreover, growth has been concentrated in developing and emerging market economies, where energy consumption has been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users.--------------------------------------------------------------------------- \2\ The dominant role of commodity prices in driving the recent increase in inflation can be seen by contrasting the overall inflation rate with the so-called core measure of inflation, which excludes food and energy prices. Core inflation has been fairly steady this year at an annual rate of about 2 percent.--------------------------------------------------------------------------- On the supply side, despite sharp increases in prices, the production of oil has risen only slightly in the past few years. Much of the subdued supply response reflects inadequate investment and production shortfalls in politically volatile regions where large portions of the world's oil reserves are located. Additionally, many governments have been tightening their control over oil resources, impeding foreign investment and hindering efforts to boost capacity and production. Finally, sustainable rates of production in some of the more secure and accessible oil fields, such as those in the North Sea, have been declining. In view of these factors, estimates of long-term oil supplies have been marked down in recent months. Longdated oil futures prices have risen along with spot prices, suggesting that market participants also see oil supply conditions remaining tight for years to come. The decline in the foreign exchange value of the dollar has also contributed somewhat to the increase in oil prices. The precise size of this effect is difficult to ascertain, as the causal relationships between oil prices and the dollar are complex and run in both directions. However, the price of oil has risen significantly in terms of all major currencies, suggesting that factors other than the dollar, notably shifts in the underlying global demand for and supply of oil, have been the principal drivers of the increase in prices. Another concern that has been raised is that financial speculation has added markedly to upward pressures on oil prices. Certainly, investor interest in oil and other commodities has increased substantially of late. However, if financial speculation were pushing oil prices above the levels consistent with the fundamentals of supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell. But in fact, available data on oil inventories show notable declines over the past year. This is not to say that useful steps could not be taken to improve the transparency and functioning of futures markets, only that such steps are unlikely to substantially affect the prices of oil or other commodities in the longer term. Although the inflationary effect of rising oil and agricultural commodity prices is evident in the retail prices of energy and food, the extent to which the high prices of oil and other raw materials have been passed through to the prices of non-energy, non-food finished goods and services seems thus far to have been limited. But with businesses facing persistently higher input prices, they may attempt to pass through such costs into prices of final goods and services more aggressively than they have so far. Moreover, as the foreign exchange value of the dollar has declined, rises in import prices have put greater upward pressure on business costs and consumer prices. In their economic projections for the June FOMC meeting, monetary policymakers marked up their forecasts for inflation during 2008 as a whole. FOMC participants continue to expect inflation to moderate in 2009 and 2010, as slower global growth leads to a cooling of commodity markets, as pressures on resource utilization decline, and as longer-term inflation expectations remain reasonably well anchored. However, in light of the persistent escalation of commodity prices in recent quarters, FOMC participants viewed the inflation outlook as unusually uncertain and cited the possibility that commodity prices will continue to rise as an important risk to the inflation forecast. Moreover, the currently high level of inflation, if sustained, might lead the public to revise up its expectations for longer-term inflation. If that were to occur, and those revised expectations were to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual inflation over the longer term. A critical responsibility of monetary policymakers is to prevent that process from taking hold. At present, accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policymakers. The possibility of higher energy prices, tighter credit conditions, and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation and some measures of inflation expectations have moved higher. Given the high degree of uncertainty, monetary policymakers will need to carefully assess incoming information bearing on the outlook for both inflation and growth. In light of the increase in upside inflation risk, we must be particularly alert to any indications, such as an erosion of longer-term inflation expectations, that the inflationary impulses from commodity prices are becoming embedded in the domestic wage- and price-setting process. I would like to conclude my remarks by providing a brief update on some of the Federal Reserve's actions in the area of consumer protection. At the time of our report last February, I described the Board's proposal to adopt comprehensive new regulations to prohibit unfair or deceptive practices in the mortgage market, using our authority under the Home Ownership and Equity Protection Act of 1994. After reviewing the more than 4,500 comment letters we received on the proposed rules, the Board approved the final rules yesterday. The new rules apply to all types of mortgage lenders and will establish lending standards aimed at curbing abuses while preserving responsible subprime lending and sustainable homeownership. The final rules prohibit lenders from making higher-priced loans without due regard for consumers' ability to make the scheduled payments and require lenders to verify the income and assets on which they rely when making the credit decision. Also, for higher-priced loans, lenders now will be required to establish escrow accounts so that property taxes and insurance costs will be included in consumers' regular monthly payments. The final rules also prohibit prepayment penalties for higher-priced loans in cases in which the consumer's payment can increase during the first few years and restrict prepayment penalties on other higher-priced loans Other measures address the coercion of appraisers, servicer practices, and other issues. We believe the new rules will help to restore confidence in the mortgage market. In May, working jointly with the Office of Thrift Supervision and the National Credit Union Administration, the Board issued proposed rules under the Federal Trade Commission Act to address unfair or deceptive practices for credit card accounts and overdraft protection plans. Credit cards provide a convenient source of credit for many consumers, but the terms of credit card loans have become more complex, which has reduced transparency. Our consumer testing has persuaded us that disclosures alone cannot solve this problem. Thus, the Board's proposed rules would require card issuers to alter their practices in ways that will allow consumers to better understand how their own decisions and actions will affect their costs. Card issuers would be prohibited from increasing interest rates retroactively to cover prior purchases except under very limited circumstances. For accounts having multiple interest rates, when consumers seek to pay down their balance by paying more than the minimum, card issuers would be prohibited from maximizing interest charges by applying excess payments to the lowest rate balance first. The proposed rules dealing with bank overdraft services seek to give consumers greater control by ensuring that they have ample opportunity to opt out of automatic payments of overdrafts. The Board has already received more than 20,000 comment letters in response to the proposed rules. Thank you. I would be pleased to take your questions. FOMC20071031meeting--170 168,MR. PLOSSER.," First quarter perhaps, but that was conditioned on inflation and inflationary expectations remaining well behaved." FOMC20071206confcall--10 8,MR. MADIGAN.," Given the circumstances that Bill discussed, policymakers might wish to explore possible policy measures that might help address the strains in bank funding markets. A range of options that involve the discount window could be considered. These options might include (1) a temporary reduction in the spread between the primary credit rate and the target federal funds rate; (2) the adoption of a term credit program, under which term credit could be extended, potentially at a lower rate than the primary credit rate, at a borrower’s initiative; and (3) the adoption of a term auction facility (TAF) at which term discount window funds would be auctioned at the System’s initiative. All these options share the potential advantage that their announcement would provide a highly visible signal of the Federal Reserve’s willingness to provide adequate liquidity to promote market functioning. At the same time, it is clear that what ails financial markets now is not simply a shortage of liquidity. There are more fundamental problems of credit losses, credit risk, and balance sheet capacity that these options cannot address. But easing banks’ concerns about access to liquidity could be helpful in the current circumstances. I will now briefly summarize the advantages and disadvantages of each of these options. Of course, various combinations of these options are also possible, at least in principle; but the marginal effectiveness of exercising multiple options is not clear, and rolling out more than one initiative might run the risk of suggesting a greater degree of concern on the part of the Federal Reserve than is actually the case. The first option is a reduction in the primary credit rate that would temporarily narrow the spread of that rate over the target federal funds rate, say to 15 or 25 basis points. This approach has several possible advantages. First, from one perspective it has the lowest operational risk, as it does not involve the creation of new discount window facilities; and by the same token, it does not require a lightning campaign to educate banks on the characteristics of a new facility. Second, this approach is simpler for the general public to understand. Third, this approach would be relatively easy to coordinate with parallel foreign central bank actions to reduce the spreads on their own lending facilities—assuming that they were inclined to do so. A reduction in the primary credit spread has some disadvantages. These disadvantages relate primarily to the difficulty in predicting the reaction of banks to the change. First, it is quite possible that the stigma of borrowing at the window would persist or even intensify. If so, a reduction in the primary credit spread would likely be ineffective in stemming money market pressures. Conversely, it is also possible that banks will respond nonlinearly to the reduction in the spread and demand quite large amounts of primary credit. Given the unpredictability of the banks’ demand for discount window funding, the Desk could experience significant difficulties in reserve management under the approach of reducing the primary credit spread. Another option would be to establish a term credit facility, under which banks could come to the window at their own volition for fixed-term discount window loans, say of twenty-eight-day maturities. This option was not covered in the memorandums that you recently received. These loans could well be priced differently from primary credit, partly to help sharpen the distinction from primary credit. This option shares some of the potential drawbacks with the first option that I discussed. In particular, it is difficult to predict how banks would react. In order to help guard against the effects of abrupt and large increases in discount window borrowing that would complicate reserve management, the Federal Reserve could require the borrower to provide advance notice of, say, two days before drawing funds. Even with this notice, however, such a program might risk triggering very large demands for discount window credit whose absolute size could pose reserve management difficulties and balance sheet issues for the Federal Reserve. Reducing this risk might require applying limits on individual banks’ borrowing through some form of rationing. Determining such limits and explaining them to the banks and the public would complicate the design, exposition, and implementation of this program. The third option that might be considered is a term auction facility. This program would be generally similar to the auction credit facility discussed by policymakers in September. The TAF has several advantages relative to the other two options. First, it would allow the Federal Reserve to retain close control over the supply of reserves because we would determine the auction amounts—at least assuming that the minimum bid rate is not binding. Second, the facility arguably has a better chance of avoiding stigma, partly because the auction format implies that no institution is being forced to borrow. Third, each auction would reveal information about the strength of the demand for funds. Finally, a TAF could also have potential longer-run benefits for managing reserves and conducting monetary policy both in routine circumstances and in circumstances of financial stress. A temporary TAF could provide valuable experience to the Federal Reserve about these possible longer-run benefits. The TAF has some potential disadvantages as well. Among these are some degree of operational risk, questions about whether the contemplated sizes of the facility would be sufficient to be effective in addressing market pressures, and the fact that no individual institution will have assurance that it will win funds at the auction. Nathan will now continue our presentation." FinancialCrisisInquiry--455 MAYO: I think the misallocation of capital in the housing market was partly facilitated by the GSEs. I personally have never covered Fannie and Freddie and those enterprises. There’s usually a separate set of analysts that covered those companies. But I think what we should have seen is the massive amount of capital that was allocated to the housing sector, government-incurred with a government guarantee, and that encouraged a whole industry off these government- sponsored entities. And that was a mistake, easy to say in hindsight. Many of us in the industry saw it for a while, and that goes back to the loan growth, some of the fastest growing areas, as I showed on my loan chart. I mean, every slice of real estate, you know, first mortgages, second mortgages, and then Wall Street certainly facilitated some of these activities. But you know what? Wall Street also met the demand. So it was kind of together—the government with Wall Street with the banks that facilitated this market. I made the general comment, I would prefer to see markets over government allocate capital, but with very strong oversight and regulation. CHRG-111shrg55479--80 Mr. Ferlauto," It is actually a very good point, but who I am concerned about are actually the large financial intermediaries, particularly mutual funds, who are seeking to do business, you know, with other large companies to sell their investment products through their 401(k) plans so that they actually may cast their votes in a way that would be looked kindly on by the CEO because they are not voting against his compensation plan, rather than voting in the interests of all the small individual investors who put their money into that fund, you know, thinking that that is the way to achieve value. And those are the kinds of conflicts that are rife in this system that we are very concerned about. Senator Johanns. Yes, and I am going to be very direct again. You and I are going to have an easy time agreeing that there are a lot of ways to be self-interested. A lot of ways. So, Mr. Castellani, let me turn to you. Based on your corporate experience, what impact does that have on your company if there is, for lack of better terminology, ease of entry here? " CHRG-111shrg52619--62 Chairman Dodd," Thanks very much. Senator Corker. Senator Corker. Thank you, Mr. Chairman, and I thank all of you for your testimony and your service. Ms. Bair, Chairman Bair, let me ask you this: Do you think that not having an entity that can do the overall resolution for complex entities is affecting the policies that we have in place right now as it relates to supporting them? Ms. Bair. It absolutely is. There is really no practical alternative to the course that has been set right now, because there is no flexibility for resolution. Senator Corker. So much of the actions that we are taking as a Congress and as an administration to support some of these entities have to do with the fact that we really do not have any way to unwind them in a logical way. Is that correct? Ms. Bair. I do agree with that. Senator Corker. I know the Chairman mentioned the potential of FDIC being the systemic regulator. What would be the things that the FDIC would need to do to move beyond bank resolution but into other complex entities like AIG, Lehman Brothers, and others? Ms. Bair. Right. Well, we think that if we had resolution authority, we actually should be separate from where we have the requirements for prudential supervision of systemic institutions. Those responsibilities are actually separated now, and I think it is a good check and balance to have the resolution authority with some back-up supervisory authority working in conjunction with the primary regulator who has responsibility for prudential supervision. In terms of resolution authority, I think that the current system--that we would like--if we were given it, is a good one. We can set up bridge banks, or conservatorships to provide for the orderly unwinding of institutions. There is a clear set of priorities, so investors and creditors know in advance what the imposition of loss will be. We do have the flexibility to deviate from that, but it is an extraordinary process that includes a super majority of the FDIC Board, the Federal Reserve Board, the concurrence of the Secretary of the Treasury and the President. So it is a very extraordinary procedure to deviate from the baseline requirement to minimize cost. So I think the model we have now is a good one and could be applied more broadly to complex financial organizations. Senator Corker. It sounds like in your opinion in a fairly easy way. Ms. Bair. Well, I think one easy step would be just to give us authority to resolve bank and thrift holding companies. I think that would be--I think there are going to be larger, more complex issues in terms of going beyond that category, what is systemic when you talk about insurance companies, hedge funds, other types of financial institutions. But, yes, I think that would be a relatively simple step that would give us all some additional flexibility, yes. Senator Corker. Thank you Mr. Dugan, you know, we talk about capital requirements and institutions, but regardless of the capital that any particular institution has, if they make really bad loans or make really bad decisions, it really does not matter how much they have, as we have seen, right? Are we focusing enough on minimum lending standards as we think about the overall regulation of financial institutions? " FOMC20071206confcall--17 15,CHAIRMAN BERNANKE.," That is a good point and a good issue. The opposite concern is that, if we announce it as being permanent and it is not successful or there is no bid, it would obviously give us a problem as well. We have tried to split the difference and say that this may be permanent depending on need, on market conditions, and on response. If we do that, it would give us the opportunity to get feedback. I would note also that, if we do this, we will be doing it under essentially an emergency provision that allows us to change Regulation A without public comment. So that, generally speaking, would point to a temporary facility. But, again, we would be clear that we would be willing to make this permanent if the conditions suggest it and if the demand is there." CHRG-111hhrg48868--531 Mr. Liddy," But it's very dependent upon what happens to market conditions around the globe. " fcic_final_report_full--523 Freddie Mac. As noted earlier, in its limited review of the role of the GSEs in the financial crisis, the Commission spent most of its time and staff resources on a review of Fannie Mae, and for that reason this dissent focuses primarily on documents received from Fannie. However, things were not substantially different at Freddie Mac. In a document dated June 4, 2009, entitled “Cost of Freddie Mac’s Affordable Housing Mission,” a report to the Business Risk Committee, of the Board of Directors, 136 several points were made that show the experience of Freddie was no different than Fannie’s: • Our housing goals compliance required little direct subsidy prior to 2003, but since then subsidies have averaged $200 million per year. • Higher credit risk mortgages disproportionately tend to be goal-qualifying. Targeted affordable lending generally requires ‘accepting’ substantially higher credit risk. • We charge more for targeted (and baseline) affordable single-family loans, but not enough to fully offset their higher incremental risk. • Goal-qualifying single-family loans accounted for the disproportionate share of our 2008 realized losses that was predicted by our models. (slide 2) • In 2007 Freddie Mac failed two subgoals, but compliance was subsequently deemed infeasible by the regulator due to economic conditions. In 2008 Freddie Mac failed six goals and subgoals, five of which were deemed infeasible. No enforcement action was taken regarding the sixth missed goal because of our financial condition. (slide 3) • Goal-qualifying loans tend to be higher risk. Lower household income correlates with various risk factors such as less wealth, less employment stability, higher loan-to-value ratios, or lower credit scores. (slide 7) • Targeted affordable loans have much higher expected default probabilities... Over one-half of targeted affordable loans have higher expected default probabilities than the highest 5% of non-goal-qualifying loans. (Slide 8) The use of the affordable housing goals to force a reduction in the GSEs’ underwriting standards was a major policy error committed by HUD in two successive administrations, and must be recognized as such if we are ever to understand what caused the financial crisis. Ultimately, the AH goals extended the housing bubble, infused it with weak and high risk NTMs, caused the insolvency of Fannie and Freddie, and—together with other elements of U.S. housing policy—was the principal cause of the financial crisis itself. When Congress enacted the Housing and Economic Recovery Act of 2008 (HERA), it transferred the responsibility for administering the affordable housing goals from HUD to FHFA. In 2010, FHFA modified and simplified the AH goals, and eliminated one of their most troubling elements. As Fannie had noted, if the AH goals exceed the number of goals-eligible borrowers in the market, they were being forced to allocate credit, taking it from the middle class and providing it to low- income borrowers. In effect, there was a conflict between their mission to advance affordable housing and their mission to maintain a liquid secondary mortgage 136 Freddie Mac, “Cost of Freddie Mac’s Affordable Housing Mission,” Business Risk Committee, Board of Directors, June 4, 2009. 519 market for most mortgages in the U.S. The new FHFA rule does not require the GSEs to purchase more qualifying loans than the percentage of the total market that these loans constitute. 137 FOMC20060131meeting--95 93,MS. PIANALTO.," Thank you, Mr. Chairman. By now I’m sure that most of you are tired of hearing me report that conditions in my District are not as vigorous as conditions in most of the country. I know that I’m tired of repeating it. Fortunately, optimism is increasing in many parts of my District. My directors and business contacts that have national and international business interests report fairly solid conditions in most of their industries. They tell me that they plan to maintain a strong pace of capital spending this year and that they expect healthy productivity gains from doing so. These trends encourage me to think that our economy will be able to maintain the 3 percent rate of structural productivity growth that underlies the Greenbook baseline projection. Since we are nearing the point of monetary policy neutrality, I’m counting on a strong rate of productivity growth to help us gradually nudge the inflation rate back down over the next several years. I have not changed my thinking about the underlying trends in the economy since our last meeting. I was pretty much in sync with the Greenbook outlook then and remain so today. The BEA’s fourth-quarter revisions appear to affect the timing of economic activity across a couple of quarters but not to affect the longer-term outlook. Even though I still expect to see headline and core inflation moderate over the projection period, I have become a bit more sensitive to the upside inflation risks in the baseline projection. First, in the Greenbook we received last week, the staff concluded that inflation this year could creep up a bit more than they had thought in December, and the staff elevated their estimate of core PCE inflation for the fourth quarter from 1.9 percent to 2.2 percent as a result of the most recent BEA report. The staff hedged against that possibility by imposing a temporary 25 basis point surtax on their December fed funds rate path beginning at our next meeting, and it seems sensible to me to keep this option open. At our December meeting I said that I thought we were very close to being able to stop increasing our fed funds rate target at every meeting. I still think so. If monetary policy is a combination of science and art, I think we’re now out of the laboratory and inside the art studio, and having flexibility as we go forward is highly desirable to me. Finally, Mr. Chairman, I have to admit that I’ve spent more time since our last meeting thinking about what to say in acknowledgement of your last meeting than I’ve thought about economic conditions, and it’s impossible to come up with words to express my feelings. I just simply want to say that it has been truly an honor and a privilege to serve under your leadership of this Committee. Thank you, Mr. Chairman." FinancialCrisisReport--574 In advance of the conference call, Mr. Lehman’s staff prepared a two-page summary of Goldman’s liquidation agent duties, the liquidation procedures specified in the CDO documents, the CDOs affected, and the assets that Goldman anticipated would be affected by the downgrades. 2570 Four days after the conference call, on July 23, 2007, Benjamin Case, who had been assigned lead responsibility for carrying out Goldman’s liquidation agent functions, circulated a draft document describing Goldman’s role. It stated that Goldman’s goal as liquidation agent was: “to attempt to maximize proceeds on the unwind of credit risk assets pursuant to the liquidation process governed by the CDO documents, rather than to liquidate at an arbitrary pre-specified time without regard to market conditions.” 2571 It identified the assets that had been classified as Credit Risk Assets and provided Goldman’s “Current Strategy” for handling them: “– wait and continue to evaluate market conditions, rather than liquidating now. - upside is that continued short-covering by hedge funds anxious to monetize profits could cause minor rally (5-10 points)[.] - downside is that speed up of foreclosure process vs. current timeline expected by market could decrease IO value, or significant forced selling of similar names by CDO vehicles could push levels wider [lower prices].” Hudson Liquidation Agent. Although the liquidation agent role was originally designed for use in Goldman’s “high grade” CDOs, where “there is substantially less credit risk in the assets vs. a mezzanine structured product CDO portfolio,” the feature was also added to some of its riskier mezzanine CDOs, including Hudson Mezzanine 2007-1 (Hudson 1). 2572 Hudson 1 was a synthetic CDO whose assets consisted entirely of CDS contracts referencing subprime RMBS or ABX assets with BBB or BBB- ratings. Goldman had selected 100% of the reference assets and held 100% of the short side of the CDO. Hudson 1’s marketing materials outlined Goldman’s liquidation agent role. The Hudson marketing booklet, for example, told potential investors: 2570 2571 7/19/2007 Goldman document, “GS Liquidation Agent Role in ABS CDOs, ” GS MBS-E-014055117. 7/23/2007 email from Mr. Case to Mr. Bieber, “CDO Liquidation Agent Role - Draft Talking Points - INTERNAL USE ONLY, ” GS MBS-E-015240358. 2572 7/17/2006 Goldman memorandum to Mortgage Capital Committee, GS MBS-E-013458155, at 57. A “mezzanine ” CDO is one in which the underlying assets carry credit ratings such as BBB or BBB-. “Hudson CDOs are non-managed and static in nature and provide term non-recourse funding where Goldman Sachs acts as Liquidation Agent on an ongoing basis. The Liquidation CHRG-110hhrg41184--123 Mr. Bernanke," The high rate of foreclosures would be adverse to the economy. Obviously, it hurts the borrowers, but it also hurts their communities if there are clusters of foreclosures. And it hurts the broader economy, because it makes the housing market weaker and that has effects on the whole economy. So clearly, if we can take actions to mitigate the rate of foreclosure, do workouts and otherwise modify loans or find ways to help people avoid foreclosure, I think that is certainly positive. Mr. Moore of Kansas. Thank you, sir. Some believe that we should enact legislation that would amend the bankruptcy code to allow judges to modify the terms of a loan on a debtor's principle residence in chapter 13 in order to provide relief to these homeowners. This would essentially treat primary residences in a similar way to credit cards under the bankruptcy code. In 1978, Congress created this exemption in the bankruptcy code with the intent of encouraging homeownership by providing certainty to mortgage lenders that terms and conditions of the loan were secure. Do you believe that changes in the bankruptcy code to make primary residence lending more akin to credit cards will place up our pressure on mortgage interest rates and what effect could this have on investor confidence and mortgage-backed securities market in the broader economy? " CHRG-110shrg50409--113 RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM BEN S. BERNANKEQ.1. The number and severity of credit rating downgrades from credit rating agencies in the last year casts doubt on the reliability of such ratings. What is the Fed doing to verify the credit rating of the collateral you are accepting at the various Fed facilities?A.1. The Federal Reserve regularly updates the credit ratings of assets pledged as collateral and uses multiple ratings rather than just one. Assets are regularly marked to market and haircuts are applied to provide adequate protection against market, liquidity, and credit risks. In cases where ratings are less reliable, we require a higher rating than we would otherwise. It should be noted that the entire pool of collateral pledged by a depository institution secures any loans to that institution; moreover, the Federal Reserve has recourse to the borrower under all of its lending facilities beyond the specific collateral pledged. Although credit ratings are one determinant of the eligibility of collateral pledged to Federal Reserve liquidity facilities, Reserve Banks also perform independent credit analysis when receiving collateral and especially when extending a loan to a depository institution. That analysis is based on publicly available information as well as on supervisory information on both the quality of the collateral and on the financial condition of the pledging institution.Q.2. In 2006, Congress passed the Credit Rating Agency Reform Act, which created a formal process for recognizing and examining credit rating agencies with a goal of increasing competition and rating quality. Under that law, the SEC has now recognized 10 National Recognized Statistical Rating Organizations. However, the Fed only accepts credit ratings from the three largest rating agencies for collateral taken at the various Fed facilities. Why does the Fed not accept ratings from the other approved agencies? Are there any plans to revisit that prohibition?A.2. The Federal Reserve accepts a very large volume of collateral, and it is critically important to be able to access credit ratings and other information on a timely basis in a fully automated fashion. The Federal Reserve is open to utilizing credit ratings of all NRSROs consistent with this basic requirement.Q.3. Given the concerns about the government-sponsored entities that led the Fed to grant them access to a lending facility and the Treasury Department to ask for rescue legislation, has the Fed changed its practices on accepting GSE-backed securities as collateral at the Fed facilities? Have you increased the collateral required when GSE-backed collateral is posted?A.3. Securities issued or guaranteed by the GSEs remain eligible collateral at the Federal Reserve's various liquidity support facilities. The market prices of GSE securities pledged as collateral are regularly updated and the haircuts are determined to provide the Federal Reserve with adequate protection against market, liquidity, and credit risk. The haircuts applied to collateral pledged by depository institutions to the discount window are regularly recalibrated by the Federal Reserve, and it has not been necessary to change those applied to GSE-related securities. Haircuts applied to securities pledged by primary dealers for repurchase agreements, the primary dealer credit facility, and the term securities lending facility are chosen to be consistent with, but slightly more conservative than, market practice.[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]" CHRG-110shrg50414--56 Mr. Lockhart," Chairman Dodd, Senator Shelby, and Members of the Committee, thank you for the opportunity to testify on the Federal Housing Finance Agency's decision to place Fannie Mae and Freddie Mac into conservatorship. Fannie Mae and Freddie Mac share the critical mission of providing stability, liquidity, and affordability to the Nation's housing market. Between them, these enterprises have $5.3 trillion of guaranteed mortgage-backed securities and debt outstanding, which is equal to the total publicly held debt of the United States. Their market share earlier this year reached 80 percent of all new mortgages made. During the turmoil that started last year, they had played a very important role in providing liquidity to the conforming mortgage market. They required capital to support a very careful and delicate balance between safety and soundness and mission. That balance was upset as house prices, earnings, and capital have continued to deteriorate. In particular, the capacity to raise capital without Treasury Department support vanished. That left both enterprises unable to fill their mission. Worse, it threatened to further damage the mortgage and housing markets if they had to sell their assets. Rather than letting those conditions worsen and put the financial markets in further jeopardy, FHFA decided to take action. The goal of these dual conservatorships is to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, reduce systemic risk, and make mortgages--and this is the most important--make mortgages available at lower cost for the American people. FHFA based its determination on five key areas, each of which worsened significantly over the last several months: First, there were accelerating safety and soundness weaknesses. Second, there was a continued and substantial deterioration in equity, debt, and MBS market conditions. Third, the current and projected financial performance and condition of each company, as reflected in the second quarter financial reports and our ongoing examination. Fourth, the inability of the companies to raise capital or to issue debt according to normal practices and prices. And, last, the critical importance of each company in supporting the country's residential mortgage market. I shared our growing concerns with Federal Reserve Chairman Bernanke, who was made our consultant in the law you passed in July, and with Secretary Paulson. They agreed that a conservatorship was necessary, as did the boards of both firms. A detailed list of events leading to our conclusion to appoint a conservator is provided in my written statement. I will just highlight a few. It became apparent during this intense supervisory review that began in July that market conditions were deteriorating much more rapidly than anybody expected. We supplemented our examination team with senior examiners from the Fed and the OCC. All three sets of examiners corroborated that there was a significant deterioration in the credit environment and it was a threat to the capital of these two companies. We also finished our semi-annual examination ratings of the companies and, across the board, there were significant and critical weaknesses. The companies themselves disclosed in their second quarter filings how rapidly the environment had deteriorated and was negatively affecting their outlook and their ability to raise capital. Freddie Mac reported losses of $4.7 billion over the last year. Fannie Mae reported losses of $9.7 billion. Now, let me turn to the conservatorships. The first signs are that the conservatorships are positive. The enterprise funding costs and the spreads on MBS have declined. This lower cost has been passed on to homebuyers, with 30-year mortgage rates well below 6 percent for the first time since January. On the first day, business opened as normal but with stronger backing for the holders of their mortgage-backed securities, their debt, and their subordinated debt. Over the next 15 months, they are allowed to increase their portfolios to provide support to the housing market. They will also be able to continue to grow their guaranteed MBS books. As the conservator, FHFA assumed the power of the board and management. Highly qualified new chief executive officers and non-executive chairmen have been appointed. They will be delegated significant powers. In order to conserve over $2 billion in annual capital, the common stock and preferred dividends were eliminated. The U.S. Treasury financing facilities, which are critical to this conservatorship, are all in place and will provide the needed support to Fannie Mae and Freddie Mac to fulfill their mission over the long term, while giving upside potential for taxpayers. FHFA will continue to work expeditiously on the many regulations needed to implement the new law. The new legislation adds, importantly, affordable housing, a trust fund, and mission enforcement to the responsibilities of the safety and soundness regulator. We are also continuing to work with the enterprises on loan modifications, foreclosure preventions, pricing, and credit issues. The decision to appoint a conservator for each enterprise was a tough but necessary one. They can now become part of the solution. Unfortunately, all the good and hard work put in by the FHFA and the enterprises was not sufficient to offset the consequences of the antiquated regulatory structure which was overwhelmed by the turmoil in the housing markets. Conservatorship will give the enterprises the time to restore the balances between safety and soundness and their mission. Working together with the enterprises, Congress, the administration, and other regulators, I believe we can restore confidence in the enterprises and, with the new legislation which you passed, build a stronger and safer future for the mortgage markets, homeowners, and renters in America. Thank you. I would be pleased to answer questions. " FOMC20080130meeting--386 384,MR. GIBSON.," The regulatory structure has been changed now as a result of the law that was passed in 2006, at least if you're talking about getting the regulatory stamp of approval from the SEC to become a nationally recognized statistical rating organization. That's now just a notification process by which, if you meet some minimum requirements, the SEC is required to okay you. So entry is now easy whereas before it used to be restricted by the SEC. In some sense there's a bit of a natural monopoly going on because, if you really had a couple of rating agencies that you trusted, it's not clear why someone would be willing to transfer from an established to a new one. But if you were to take some of our recommendations to the next level and talk about how you would actually implement this and how you would go about making this have some success, one thing people have suggested is that maybe we should help investors set up their own rating agencies-- maybe they don't want to do that now--and maybe more transparency from the existing rating agencies and from the issuers. It would then be easier for a new rating agency that's funded by investors to get going and get some traction if there were more transparency around the whole process. That's just one possibility " FOMC20081029meeting--248 246,MR. KOHN.," Thank you, Mr. Chairman. A number of the presentations yesterday talked about falling off a cliff in the middle of September. I think we need to remind ourselves that we were sliding downhill pretty fast before we hit that cliff. The third-quarter data, which aren't really affected by what happened in the last two weeks of September, indicate that the economy was weaker than we thought at the time of the last FOMC meeting. I think Dave Stockton or Norm Morin noted that about a third of their downward revision reflected incoming data rather than the credit tightening. That was especially true for consumption, with real consumption spending falling through the summer, responding to lower employment and tighter credit. Private domestic final purchases were revised down to a decline of 3� percent in the third quarter after being flat in the first half. Housing price declines picked up in August, and I think the deteriorating economy and concerns about the economy were reflected in increased nervousness in financial markets over the summer into the first half of September. It was really those worries about what the losses were going to be and how they would spread from mortgages to loan books generally--that deepening pessimism--that doomed the marginal institutions like AIG and Lehman and the GSEs. They just didn't have a chance to recapitalize or stabilize themselves when so many of the other market participants were worried about what their own positions would be. The resulting flight to liquidity and safety, the loss of confidence that followed, the deepening gloom, and the failures and near failures and associated losses triggered a tremendous tightening of financial conditions over the intermeeting period--President Yellen and others discussed this--despite the 50 basis points of easing. Even after the 900 point increase yesterday, equity prices are down about 20 or 22 percent over the intermeeting period. The dollar is up 10 percent. Corporate borrowing rates are up for investment-grade corporations 200 to 250 basis points. Banks tell us that they're tightening across every dimension of their lending; and other lenders, like finance companies, are also cutting back very, very sharply. You can see this in autos clearly, but the stress is much broader than just the auto finance companies. We have good programs in place to deal with many of these problems--the capital, the FDIC guarantees, and the Federal Reserve balance sheet facilities--and they are having some effects relative to the freezing up of markets that we had in mid-September. We can see that interbank spreads and LIBOR have come down some. Commercial paper rose, I guess, on Monday with the introduction of our facility. Declines in money market mutual funds have abated, though they're still there, and there are some signs that maturities are beginning to lengthen in funding markets. As these programs are more fully implemented, we'll see some greater effects--including, I hope, some greater willingness to extend credit. I also assume that the fiscal package is necessary, as in the Greenbook ""fiscal stimulus"" alternative. But we need to remember that the improvement we've seen over the last couple of days is relative to a situation in which funding markets were in effect frozen beyond a very short term, and although a sharp snapback is possible, as President Plosser was noting yesterday, I think further gains are more likely to be gradual. In the past few days, the declines in LIBOR have seemed very grudging and gradual, and LIBOR remains quite high--I think close to 75 basis points higher-- relative to what it was in mid-August, before we even cut rates. This was three-month LIBOR that I looked at this morning. In an environment of economic weakness, spreading credit problems, falling house prices, a number of false dawns in this episode so far, and death and near-death experiences, lenders and investors are going to continue to be very cautious and conserve their liquidity and capital. So despite further improvements, financial conditions will remain quite tight. The effects of lower wealth, higher borrowing costs, the stronger dollar, and tighter nonprice terms of credit will play out over the next few quarters, putting downward pressure on an economy that was already in recession. At the same time, heightened uncertainty and fear of future problems caused a sharp deterioration in attitudes and spending even apart from the effects of credit. Judging from the Conference Board index, regional purchasing manager surveys, and anecdotes--including what we heard around the table yesterday--it feels like a recessionary psychology, as I think Charlie Evans called it. Others talked about pulling back and curtailment of discretionary spending in train, and this is not just caused by credit effects. This is just fear. So we've had a downward shift in aggregate demand as well as a movement along the aggregate demand curve, and this downward shift in aggregate demand will propagate through multiplier�accelerator effects even if attitudes begin to improve some. The global dimensions of the shock are important. As we talked about yesterday, heightened risk aversion has had a pronounced effect on emerging market economies as well as on industrial economies. Net exports cushioned domestic weakness in the first half of the year, but with the dollar strong, if anything we'll be absorbing weakness from abroad, not exporting it, as the rest of the year goes on and we get into next year. Growing credit problems abroad will only add to pressures on many large global lenders who might have thought they were diversified geographically. But a little like our U.S. housing market, they will find that diversification doesn't really work when there's a global recession. The net effect of all of this is a much weaker growth path for the economy. In my forecast, I had a somewhat steeper near-term decline in economic activity and a slightly sharper bounceback than the staff, including my fiscal assumption, but I also have the unemployment rate peaking at over 7 percent, as the Greenbook did. With commodity prices plunging, the added slack maintained through several years, and declines in inflation expectations, inflation will be on a clear downward track. In the Greenbook, this downward track for inflation obtained even with the assumption of some rebound in commodity prices and the resumption of dollar weakness. In my forecast for inflation from next year on, inflation was at or below the 1� to 2 percent rate I would like to see as a steady state consistent with avoiding the zero bound when adverse shocks hit. Critically, the downside risks around activity forecasts are huge and tilted to the downside. I think they're huge because we've never seen a situation like this before, certainly not in my experience dating all the way back to 1970, and have only the vaguest notion of how it will play out in financial markets and spending. I think they're tilted to the downside because I, like the staff, assumed a gradual improvement in financial markets. That could be delayed or even go in the wrong direction for a time, further tightening financial conditions. In addition, the effect on spending of the heightened concerns and tighter credit conditions could be larger and longer lasting than I assumed. For some time an important downside risk to the forecast has been a sharp upward revision to household saving as wealth, job availability, and borrowing capacity eroded. I assumed a moderate increase in the saving rate, but I can definitely see the possibility that adverse developments will galvanize a more thorough rethinking by the household sector of what saving is needed, and that will affect investment as well as consumption. We'll get to the policy implications of all of this in the next round. Thank you, Mr. Chairman. " CHRG-110shrg50414--213 Secretary Paulson," Well, we have thought a lot about it. We need a systemic approach, and again, I think it is--I have described the systemic approach. I have also heard conversations about taking equity stakes, various other things, and I just believe very strongly if you impose these kinds of conditions, if you impose any kind of punitive conditions, this program won't work and we will all lose. And---- Senator Bayh. This wouldn't be punitive. This is including the private sector along with the public sector in answering the problem and---- " CHRG-111hhrg58044--150 Mr. Hinojosa," Thank you, Mr. Chairman. Chairman Gutierrez, I want to thank you for holding this important hearing on a very important issue, consumer credit. I commend my colleague, Congresswoman Mary Jo Kilroy, for introducing H.R. 3421, the Medical Debt Relief Act of 2009. The intent of her legislation is admirable. I agree with her that medical debt should be removed from credit reports 30 days after that debt has been repaid or settled, and that it not continue to hurt the credit rating of that individual, having gone through so many difficulties with sickness. I am concerned about one issue involving credit reporting agencies. They buy and sell information from virtually all adult residents in the United States. For a long time, we have been encouraging them to provide credit reports in languages other than English, especially Spanish. Mr. Chairman, I would ask that each credit reporting agency provide in writing their proposals to provide credit reports in languages other than English or that we at least have an opportunity to debate that. I would like to ask my question to Mr. Snyder. I am interested in legislation that would require that every adult American citizen 21 years or older receive a free credit score on an annual basis. Would the American Insurance Association support such legislation? " FOMC20070918meeting--151 149,MR. KOHN.," Thank you, Mr. Chairman. I’ll be glad if you don’t tell how many years of experience I have around this table. [Laughter] I support the action and the language of alternative B for the reasons that have been given by many others around this table. I think that the odds favor a significant reduction in aggregate demand owing to the financial conditions we’ve all been talking about. I agree with Governor Mishkin that part of the disruptive effects of the financial conditions are the small chance of a very adverse effect—the sort of interactions you were talking about, Mr. Chairman. Holding back and doing just 25 in that context would be a mistake. Going ahead and doing 50 will largely relieve some uncertainty. With regard to some of the comments about language, the discussion of credit conditions in financial markets in paragraph 2, I guess my read of what we talked about today was just this, and it seems to me that the way it is now is very transparent. It’s a nice replication of the discussion we have had, and so I don’t see a need to subtract language about financial markets from this. With regard to the balance of risks in paragraph 4, also consistent with our discussion is the sense that there’s a huge amount of uncertainty about how things are going to evolve, both the markets and the effect on the economy. I don’t feel as though I know enough to say that the risks are balanced. I don’t know. The range of outcomes is just too wide, and there’s very little central tendency in it. So I’d be very uncomfortable with a statement saying that I kind of thought the risks were balanced. I am much more comfortable with a statement that says there is a lot of uncertainty out there and that’s uncertainty around the economic outlook. So I think the current language in paragraph 4 is also a nice representation of the discussion we had today and consistent with our ignorance. I’m not concerned about the moral hazard issues. I think our job is to keep the economy at full employment and price stability and let asset markets fluctuate around that. There will be winners and losers. That’s fine. The Congress told us to have maximum employment and stable prices, and that’s what we should be about here. Sometimes that means you need to move to keep employment maximum or prices stable, and we need to take account of the asset markets but not worry about the effects of those actions on asset markets per se. Holding back—inertia—because of concerns about moral hazard would be a serious mistake. We shouldn’t hold interest rates higher than they need to be in order to impose additional cost on borrowers to teach lenders a lesson. Too many innocent bystanders would be hurt in that process. Thank you, Mr. Chairman." FOMC20080625meeting--92 90,MR. KOHN.," Thank you, Mr. Chairman. My forecasts for both economic growth and inflation are within the central tendency of the rest of you and a little stronger than the staff's outlook. In fact, my 2008 projections for economic activity for the second half of the year were revised very little from two months ago. Growth turned out to be stronger than I expected in the first half, and that carries some weight going forward; but financial conditions are tighter with higher bond rates and lower equity prices, and of course oil prices are a lot higher and that will damp demand going forward. So I expect slow growth in the second half followed by expansion around, maybe a little above, the rate of growth of potential in '09 and '10, with the same basic story that everybody else has: drags on activity from declining housing activity, decreasing wealth, tight credit conditions, and higher petroleum prices. All of those drags will abate over time, allowing the natural resilience, with slightly accommodative financial conditions, to show through, and I assume a gradual tightening of monetary policy beginning next year. Incoming information on prices and costs has been mixed. Oil and food price increases will raise headline inflation, but core has been stable and has come in a little to the soft side of expectations, and labor costs as yet show no signs of accelerating. Going forward, I see a sharp decline in headline inflation later this year with the assumed leveling-out in oil prices and a gradual decrease in core as economic slack inhibits wage and price increases, offsetting the pass-through from oil prices. Now, that's my central tendency. I consider the odds on that being realized to be even lower than usual, and the usual odds are disappearingly small. It seems to me that the defining characteristics of the current situation are uncertainty and risk. We're facing multiple shocks, many of them unprecedented in size and persistence, in the housing market, financial markets, and commodities. The outlook is full of puzzles, and in my mind anyone who thinks he or she understands what's going on is either a lot smarter than I am or delusional--or both. [Laughter] I class the risks for both output and headline inflation as greater than usual, and let me tell you about some of the things I wrestled with. Financial conditions, are they accommodative? I continue to believe that the 2 percent nominal funds rate is not indicative of a highly accommodative financial condition, given the current state of financial markets. That is, in my view we have limited insurance. Spreads have widened sufficiently over the past 10 months both for long-term and short-term credit, and bank terms and conditions for loans and lines of credit have tightened enough that only a small part of the drop in the fed funds rate is showing through to the cost of capital for median households and firms. The staff's flow of funds estimates show a marked deceleration in the growth of both household and business debt in the first half of this year, from 10 percent for households last year to 3 percent in the first half of the year and from 12 percent for businesses to 7 percent in the first half of the year. A 2 percent fed funds rate will become accommodative as spreads narrow and financial functioning returns more toward normal, and that's one reason I assumed a gradually rising federal funds rate over 2009 and forward. The evidence about improving financial markets over the intermeeting period was decidedly mixed. Some spreads did come in from late April. Investment-grade businesses tapped bond markets in size, but almost all spreads remain unusually wide. We were reminded of the fragility of the evolving situation, especially in the financial sector, with the worries about continuing credit problems resulting in sharp declines in equity prices on financials and an uptick in their CDS spreads, which had narrowed the previous month or two; the downgrading of monolines and investment banks; and the increasing attention to the problems of regional banks. It would be surprising if these were not reflected in even greater caution by banks and other lenders in their lending practices. Also the securitization markets, especially for non-agency mortgages, are not functioning in a way to replace bank intermediation. This is going to be a prolonged process of reintermediation, deleveraging, and building liquidity with an uncertain endpoint. Like the staff, I assume that the conditions return to something approaching normal over the next 18 months, but the risks are skewed toward an even longer recovery period. The second topic is household spending. Households are facing a huge number of adverse shocks: higher oil prices, tighter credit, declining house prices, and rising unemployment. It's not surprising that confidence is at recessionary levels. It is surprising that spending is so resilient. I assumed that the saving rate would rise very gradually once the tax rebate effects wore off, but I think a more abrupt and sizable increase in household saving is a distinct downside risk. What about housing? Some sales measures have shown a few tentative indications of leveling off. I was encouraged by President Lockhart's report from Florida, but I'm also struck by renewed pessimism about housing in the financial markets. Equities of construction firms and builders have declined after stabilizing, actually rising, earlier this year. ABX indexes have turned down, reversing earlier improvements; and perhaps underlying the previous two developments, the Case-Shiller futures indexes remain in steep decline, though today's information was less weak than expected. The view of the financial markets, anyhow, is that the light at the end of the housing tunnel is receding, and declines in expected house prices must be an important reason for the erosion in market confidence in financial intermediaries. In sum, although the incoming data may have reduced the threat of a sharp drop in spending, in my view there remains a very pronounced downward skew around my outlook for modest growth in H2 and a strengthening next year. However, that downward skew around output did not translate into a downward skew around my forecast for headline inflation. In fact, I saw the risks on headline inflation as tilted to the upside, though roughly balanced around the gradual decrease in core. I think the upside risks result from two additional areas of uncertainty. One area is commodity prices, though the trend increases in commodity prices over the past few years can be attributed to rising demands from emerging market economies relative to sluggishly responding supplies. Despite Nathan's best efforts, I really don't think we have much of a clue about the cause of the spike in oil prices this year. It has been especially striking to me over the intermeeting period, when the prices of industrial commodities have been falling on balance. Presumably prices in these markets already incorporate expectations of reasonably strong global growth outside the United States as in the Greenbook. Absent any surprises, futures market quotes ought to be the best guide, but what we don't understand can fool us, especially when so much of the relevant information involves emerging market economies, where data are sparse and of questionable value. Given our experience over the past few years, I think continued increases in commodity prices would seem to be an upside risk. The other area is inflation expectations. I assume that as headline inflation comes down, both short- and long-term inflation expectations, especially in the survey data, will reverse their recent increases based a lot on the kind of information that President Yellen was observing about how the household survey has tended to follow contemporaneous inflation. I'm encouraged by the relatively flat readings on core inflation and labor compensation increases. Higher expectations have not so far become embedded in prices and costs, despite all the talk of passing along cost increases. But headline inflation is going to rise before it falls. Real wages will be further eroded by higher energy costs. Although this is a necessary part of an adjustment to an adverse terms-of- trade shock, it will be resisted. Hence, a further rise in inflation expectations and a stronger determination by households and businesses to act on those expectations will be a risk over coming months. With that further rise in oil prices, it's a bigger risk than it was a couple of months ago. In terms of the long-term projections, Mr. Chairman, I think I'm fine with something like your proposal. Our objective for adding a year was to give the public a better sense of where we're going over the long term. Given the shock to the economy, that's not as informative as it was before. I think we're close to where most people would say their inflation objective was, but not for the growth rate of potential or the NAIRU. I could live with option 3 or President Bullard's alternative to that--to state exactly what our long-term expectations are instead of talking about five to seven years or five to ten years. I don't think we'll gain a lot. I don't think the costs or benefits are very large on either side of this. Our problems now are not that people don't understand where we're going in the end. I think they have a pretty good idea that we want inflation to be a lot lower than it has been. But I think they don't really understand how we're going to get either to full employment or to price stability, given where we're starting. So I think the uncertainty about our objectives is a very small problem relative to the other problems now. But if we can reinforce what those objectives are, it might help a little around the edges. I do worry, as President Lacker said, that what we say about output and employment not be interpreted as goals but rather as a judgment about the state and the structure of the economy. I am hopeful that we could take care of that in what we say about what we're publishing. Thank you, Mr. Chairman. " CHRG-111hhrg58044--373 Chairman Gutierrez," You should ask them and come back and let us know. Again, I do not know. We are going to ask them because it says, ``Equifax is no longer selling credit reports for employment screening.'' It says, ``used to determine eligibility, and while it is perfectly legal under the Fair Credit Reporting, the company seems to have proactively decided that selling reports to employers was not worth the trouble.'' In other words, they see trouble on the horizon with this, probably due to discriminatory actions that might or might not take place. We are going to ask them as part of our process. We are going to ask them to come here. I think it is an interesting question. If there are three credit bureaus and one of them does not want to go through the trouble, I would like to know what the ``trouble'' is. It is not about denying people information. It is just correct information. I would encourage everyone here on this panel and anyone listening, since through Congress and a law which we on this side of the aisle advocated, you now get your credit report once a year. It does not give you your credit score, only the credit report. The credit score is still a little more murky, but you get your credit report. Listen, go get one. When you see the mistakes that are in your credit, that is what we want. It is almost as though we depart from the premise that the credit bureaus are somehow, I do not know, omnipotent, they do not create any errors or mistakes. I would like to just ask one last question and that is I want to go back very, very quickly to Mr. Rukavina. They told us earlier that if I am sick, that it is put in my credit report but does not have an impact on my credit score. Just elaborate very quickly on that. " CHRG-110hhrg46593--375 Mr. Feldstein," My first choice would be that they go through Chapter 11. My second choice would be that any money that is given to them be given under the kind of conditions that would make them long-term viable, which, to me, means a rewriting of the labor contracts, the fringe benefits, the retiree benefits. " CHRG-109hhrg31539--147 Mr. Bernanke," Congressman, I agree with you. Growth doesn't cause inflation; what causes inflation is monetary conditions or financial conditions that stimulate spending which grows more quickly than the underlying capacity of the economy to produce. Anything that increases the economy to produce, be it greater productivity, greater workforce, or other factors that are productive, is only positive. It reduces inflation. " FOMC20080724confcall--6 4,MS. KRIEGER.," Thank you, Debby. Regarding the longer-term TAF, a transition from the current biweekly schedule of 28-day auctions, $75 billion each, to a schedule of biweekly 84-day auctions, $25 billion each, will require four additional biweekly auctions of 28-day credit for an eight-week period. We need to do this to keep the amount of TAF credit outstanding at $150 billion. We contemplate a schedule that permits us to auction the 84-day credit of $25 billion on the now-typical Monday ""cycle,"" announce these results Tuesday morning, and then auction 28-day credit Tuesday afternoon. The two auctions will settle Thursday of that week, the day other TAF credit matures. We are also requesting that we enhance the collateral protection for the Reserve Banks against term loans. Specifically, we are seeking a collateral cushion on term loans. The cushion is meant to provide protection to Reserve Banks if there are unanticipated needs for overnight credit during the term of the loan as well as serve as a collateral buffer that provides for deterioration in the value of the collateral or the creditworthiness of the depository institution (DI). This would apply to both TAF loans and term primary credit loans. Currently, there is a requirement that a TAF auction bid, plus other term credit that will be concurrently outstanding, not exceed 50 percent of available collateral. However, this requirement is only for the time when the bid is submitted. We imposed this as a modest measure of comfort that DIs would have adequate access to collateral to cover unanticipated needs for additional credit during the term of the TAF loan. This collateral cushion has not been an element of the term primary credit borrowing program, first introduced in August 2007. Under the current collateral policy for the TAF bids, we observe that some DIs add collateral just before an auction and withdraw the excess amount after the auction. That is, they do not maintain the cushion during the actual term of the loan. Particularly for the longer-term TAF and also for the term primary credit loans, we feel that Reserve Banks should have access to additional collateral. As I noted above, this would provide a cushion for unanticipated needs for additional credit during the term of the loan and for deterioration in the value of the collateral or the creditworthiness of the DI. An alternative would be to alter the haircuts themselves, but that could have other negative market consequences. In fact, for that reason, the Federal Reserve stated publicly in August that it was not changing its haircuts amid the uncertain market conditions. Specifically, the requirement we are proposing is that a DI's aggregate term borrowings not exceed 75 percent of available collateral. Most current holders of term credit have sufficient collateral to meet this requirement. We do not feel that this will restrict participation in any significant way. As is the case currently, the terms for TAF bidding and outstanding extensions of credit will require that Reserve Banks be collateralized to their satisfaction and that they take additional measures, including the right to ask for more collateral or to call a loan, if they feel insecure. Other terms of the auctions will remain as they are today: maximum bids and awards of 10 percent of the auction size, minimum bid size of $10 million, maximum of two bid rates, minimum bid rate based on the OIS rate, et cetera. These seem to have been working well, and we see no need to request any changes. We would be happy to answer your questions. Thank you. " CHRG-111hhrg48868--250 Mr. Polakoff," I was aware of the financial condition of FP, yes sir. " FOMC20081216meeting--496 494,MR. DUDLEY.," The way I look at it, President Lacker, is that the deleveraging process is happening at a very rapid rate, and that speed can cause quite a bit of damage to financial conditions and, therefore, to the real economy. To the extent that we intervene and slow down the pace of that deleveraging, we can probably mitigate the degree of damage to financial conditions and to the real economy. That's how I think about it. " CHRG-111shrg53176--87 Mr. Breeden," Just on say on pay, real briefly, I am chairman of the Board of H&R Block, and we put say on pay in voluntarily last year. It works fine. It is good to let shareholders express their views. If they do not like your pay policies, then you ought to find out about it sooner rather than later. And we did the same thing at Zale Corporation, where I am on the board. We put it in voluntarily. I think the American business community has been resisting something that is simple, easy and an appropriate step to take. I share Arthur's concern that say on pay alone is not going to fix our compensation problems. You really have to have some ability--if compensation committees do outrageous things--and we have all seen examples of profligate compensation that can get seriously out of whack. You have to go beyond that and have either majority voting every year where shareholders can try and withhold votes or voting against members of a compensation committee. And, ultimately, you have to have the threat that if boards do not do a good job managing compensation policy, that they could be replaced. And until you do that, an advisory vote that just every year says you are doing a terrible job is not going to solve the problem. " CHRG-111hhrg56776--3 Mr. Bachus," Thank you, Mr. Chairman. As Congress looks at ways to reform the country's financial infrastructure, we need to ask whether bank supervision is central to central banking. It is worth examining whether the Federal Reserve should conduct monetary policy at the same time it regulates and supervises banks or whether it should concentrate exclusively on its microeconomic responsibilities. It is no exaggeration to say the health of our financial system depends on getting this answer right. Frankly, the Fed's performance as a holding company supervisor has been inadequate. Despite its oversight, many of the large complex banking organizations were excessively leveraged and engaged in off balance sheet transactions that helped precipitate the financial crisis. Just this past week, Lehman Brothers' court-appointed bankruptcy examiner report was made public. The report details how Lehman Brothers used accounting gimmicks to hide its debt and mask its insolvency. According to the New York Times, all this happened while a team of officials from the Securities and Exchange Commission and the Federal Reserve Bank of New York were resident examiners in the headquarters of Lehman Brothers. As many as a dozen government officials were provided desks, phones, computers, and access to all of Lehman's books and records. Despite this intense on-site presence, the New York Fed and the SEC stood idle while the bank engaged in the balance sheet manipulations detailed in the report. This raises serious questions regarding the capability of the Fed to conduct bank supervision, yet even if supervision of its regulated institutions improved, it is not clear that oversight really informs monetary policy. If supervision does not make monetary policy decisions better, then the two do not need to be coupled. Vince Reinhart, a former Director of the Fed's Division of Monetary Affairs and now a resident scholar at the American Enterprise Institution, said that collecting diverse responsibilities in one institution is like asking a plumber to check the wiring in your basement. It seems that when the Fed is responsible for monetary policy and bank supervision, its performance in both suffers. Microeconomic issues cloud the supervisory judgments, therefore impairing safety and soundness. There are inherent conflicts of interest where the Fed might be tempted to conduct monetary policy in such a way that hides its mistakes by protecting the struggling banks it supervises. An additional problem arises when the supervision of large banks is separated from small institutions. Under Senator Dodd's proposal, the Fed would supervise 40 or 50 large banks, and the other 7,500 or so banks would be under the regulatory purview of other Federal and State banking agencies. If this were to happen, the Fed's focus on the mega banks will inevitably disadvantage the regional and community banks, and I think on this, Chairman Bernanke, you and I are in agreement, that there ought to be one regulator looking at all the institutions. H.R. 3311, the House Republican regulatory reform plan, would correct these problems. It would refocus the Fed on its monetary policy mandate by relieving it of its regulatory and supervisory responsibilities and reassign them to other agencies. By contrast, the regulatory reform legislation passed by the House in December represented a large expansion of the Fed's regulatory role since its creation almost 100 years ago. Senator Dodd has strengthened the Fed even more. His regulatory reform bill empowers the Fed to regulate systemically significant financial institutions and to enforce strict standards for institutions as they grow larger and more complex, adopts the Volcker Rule to restrict proprietary trading and investment by banks, and creates a new consumer financial protection bureau to be housed and funded by the Fed. In my view, the Democrats are asking the Fed to do too much. Thank you again, Mr. Chairman, for holding this hearing. I look forward to the testimony. " Mr. Watt," [presiding] I thank the gentleman for his opening statement. Let me see if I can try to use some of the chairman's time and my time to kind of frame this hearing in a way that we will kind of get a balanced view of what folks are saying. The Federal Reserve currently has extensive authority to regulate and supervise bank holding companies and State banks that are members of the Federal Reserve System, and foreign branches of member banks, among others. Last year, the House passed our financial services reform legislation that substantially preserved the Fed's power to supervise these financial institutions. The Senate bill recently introduced by Senator Dodd, however, would strip the Fed's authority to supervise all but approximately the 40 largest financial institutions. This hearing was called to examine the potential policy implications of stripping regulatory and supervisory powers over most banks from the Fed, especially the potential impact this could have on the Fed's ability to conduct monetary policy effectively. Proponents of preserving robust Fed supervision authority cite three main points to support their position that the Fed should retain broad supervisory powers. First, they say that the Fed has built up over the years deep expertise in microeconomic forecasting of financial markets and payment systems which allows the effective consolidated supervision of financial institutions of all sizes and allows effective macro prudential supervision over the financial system. Proponents of retaining Fed supervision say this expertise would be costly and difficult if not impossible to replicate in other agencies. Second, the proponents say that the Fed's oversight of the banking system improves this ability to carry out central banking responsibilities, including the responsibility for responding to financial crises and making informed decisions about banks seeking to use the Fed's discount window and lender of last resort services. In particular, proponents say that knowledge gained from direct bank supervision enhances the safety and soundness of the financial system because the Fed can independently evaluate the financial condition of individual institutions seeking to borrow from the discount window, including the quality and value of these institutions' collateral and their overall loan portfolio. Third, proponents say that the Fed's supervisory activities provide the Fed information about the current state of the economy and the financial system that influences the FOMC in its execution of monetary policy, including interest rate setting. On the flip side, there obviously are many critics of the Fed's role in bank supervision. Some of these critics blast the Fed for keeping interest rates too low for too long in the early 2000's, which some say fueled an asset price bubble in the housing market and the resulting subprime mortgage crisis. Consumer advocates and others accuse the Fed of turning a blind eye to predatory lending throughout the 1990's and 2000's, reminding us that Congress passed the HOEPA legislation in 1994 to counteract predatory lending, but the Fed did not issue final rules until well after the subprime crisis was out of control. Other critics accuse the Fed of ignoring the consumer protection role during supervisory examinations of banks and financial institutions across a wide range of financial products, including overdraft fees and credit cards and other things. Perhaps the appropriate policy response lies somewhere between the proponents and critics of the Fed bank supervision. I have tried to keep an open mind about the role of the Fed going forward, and hope to use today's hearing to get more information as we move forward to discussions with the Senate, if the Senate ever passes a bill. We are fortunate to have both the current Chairman and a former Chairman who are appearing today to inform us on these difficult issues, and with that, I will reserve the balance of our time and recognize Dr. Paul, my counterpart, the ranking member of the subcommittee. Dr. Paul. I thank the chairman for yielding. Yesterday was an important day because it was the day the FOMC met and the markets were hanging in there, finding out what will be said at 2:15, and practically, they were looking for two words, whether or not two words would exist: ``extended period.'' That is, whether this process will continue for an extended period. This, to me, demonstrates really the power and the control that a few people have over the entire economy. Virtually, the markets stand still and immediately after the announcement, billions of dollars can be shifted, some lost and some profits made. It is a system that I think does not have anything to do with free market capitalism. It has to do with a managed economy and central economic planning. It is a form of price fixing. Interest rates fixed by the Federal Reserve is price fixing, and it should have no part of a free market economy. It is the creation of credit and causing people to make mistakes, and also it facilitates the deficits here. Congress really does not want to challenge the Fed because they spend a lot. Without the Fed, interest rates would be very much higher. To me, it is a threat to those of us who believe in personal liberty and limited government. Hardly does the process help the average person. Unemployment rates stay up at 20 percent. The little guy cannot get a loan. Yet, Wall Street is doing quite well. Ultimately, with all its power, the Fed still is limited. It is limited by the marketplace, which can inflate like crazy. It can have financial bubbles. It can have housing bubbles. Eventually, the market says it is too big and it has to be corrected, but the mistakes have been made. They come in and the market demands deflation. Of course, Congress and the Fed do everything conceivable to maintain these bubbles. It is out of control. Once the change of attitude comes, when that inflated money supply decides to go into the market and prices are going up, once again the Fed will have difficulty handling that. The inflationary expectations and the velocity of money are subjectively determined, and no matter how objective you are about money supply, conditions, and computers, you cannot predict that. We do not know what tomorrow will bring or next year. All we know is that the engine is there, the machine is there, the high powered money is there, and of course, we will have to face up to that some day. The monetary system is what breeds the risky behavior. That is what we are dealing with today. Today, we are going to be talking about how we regulate this risky behavior, but you cannot touch that unless we deal with the subject of how the risky behavior comes from easy money, easy credit, artificially low interest rates, and the established principle from 1913 on that the Federal Reserve is there to be the lender of last resort. As long as the lender of last resort is there, all the regulations in the world will not touch it and solve that problem. I yield back. " CHRG-111shrg57319--487 Mr. Killinger," Well, again, market conditions changed very dramatically with housing prices coming down and there are a number of things that we changed. As you heard this morning, we tightened underwriting. We changed loan products. We ceased offering some of the subprime products. We ceased offering Option ARMs. We started to go back to more documentation on the loans. And there were just a number of things that became more appropriate because the housing conditions changed so dramatically. Senator Kaufman. So it was just right then when you really found out how bad stated loans were? " CHRG-111shrg52619--21 Mr. Fryzel," Thank you, Chairman Dodd, Ranking Member Shelby, and Members of the Committee. As Chairman of the National Credit Union Administration, I appreciate this opportunity to provide the agency's position on regulatory modernization. Federally insured credit unions comprise a small but important part of the financial institution community, and I hope NCUA's perspective on this matter will add to the understanding of the unique characteristics of the credit union industry and the 90 million members they serve. The market dislocations underscore the importance of your review of this subject. I see a need for revisions to the current regulatory structure in ways that would improve Federal oversight of not just financial institutions, but the entire financial services market. My belief is that there is a better way forward, a way that would enable Federal regulators to more quickly and effectively identify and deal with developing problems. Before I express my views on possible reforms, I want to briefly update you on the condition of the credit union industry. Overall, credit unions maintained reasonable performance in 2008. Aggregate capital level finished the year at 10.92 percent, and while earnings decreased due to the economic downturn, credit unions still posted a 0.30 percent return on assets in 2008. I am pleased to report that even in the face of market difficulties, credit unions were able to increase lending by just over 7 percent. Loan delinquencies were 1.3 percent, and charge-offs were 0.8 percent, indicating that credit unions are lending prudently. Credit unions are fundamentally different in structure and operation than other types of financial institutions. They are not-for-profit cooperatives owned and governed by their members. Our strong belief is that these unique and distinct institutions require unique and distinct regulation, accompanied by supervision tailored to their special way of operating. Independent NCUA regulation has enabled credit unions to perform in a safe and sound manner while fulfilling the cooperative mandate set forth by Congress. One benefit of our distinct regulatory approach is the 18-percent usury ceiling for Federal credit unions that enhances their ability to act a low-cost alternative to predatory lenders. Another is the existence of a supervisory committee for Federal charters, unique among all financial institutions. These committees, comprised of credit union members, have enhanced consumer protection by giving members peer review of complaints and have supplemented the ability of NCUA to resolve possible violations of consumer protection laws. NCUA administers the National Credit Union Share Insurance Fund, the Federal insurance fund for both Federal and State-chartered credit unions. The fund currently has an equity ratio of 1.28 percent. The unique structure of the fund where credit unions make a deposit equal to 1 percent of their insured shares, augmented by premiums as needed, to keep the fund above a statutory level of 1.20 percent has resulted in a very stable and well-functioning insurance fund. Even in the face of significant stress in the corporate credit union part of the industry, stress that necessitated extraordinary actions by the NCUA board to stabilize the corporates, the fund has proven durable. I want to underscore the benefits of having the fund administered by NCUA. Working in concert with our partners in the State regulatory system, NCUA uses close supervision to control risks. This concept was noted prudently by GAO studies over the years, as were the benefits of a streamlined oversight and insurance function under one roof. This consolidated approach has enabled NCUA to manage risk in an efficient manner and identify problems in a way that minimizes losses to the fund. NCUA considers the totality of our approach for mixed deposit and premium funding mechanism to unify supervisory and insurance activities, to be the one that has had significant public policy benefits, and one worth preserving. Whatever reorganization Congress contemplates, the National Credit Union Share Insurance Fund should remain integrated into the Federal credit union regulator and separate from any other Federal insurance funds. Regarding restructuring of the financial regulatory framework, I suggest creating a single oversight entity whose responsibilities would include monitoring financial institution regulators and issuing principles-based regulations and guidance. The entity would be responsible for establishing general safety and soundness standards, while the individual regulators would enforce them in the institutions they regulated. It would also monitor systemic risks across institution types. Again, for this structure to be effective for federally insured credit unions and the consumers they serve, the National Credit Union Share Insurance Fund should remain independent in order to maintain the dual NCUA regulatory and insurance roles that have been tested and proven to work for almost 40 years. I appreciate the opportunity to provide testimony today and would be pleased to answer any questions. " CHRG-110shrg50420--12 Chairman Dodd," Now, just on the second question related--I thank you for your answer to that question. That has been the view of this Senator for a long time over the last number of weeks that this matter has been discussed. There has been a debate, obviously, as to whether or not that exists, but I appreciate the clarity from the GAO on that question. The authority clearly exists, and the right to condition that assistance as well, which gets to the point of a trustee or a board, an oversight board. And I agree with you totally on that, I think having this disbursal of resources occur not on a lump-sum basis but, rather, conditioned on the performance of how things are moving forward with the various ideas that we are hearing from the industry itself. Tell me, though, in terms of the GAO's assessment in reference to the oversight board, how do you--one, did they require greater public scrutiny? I believe we did, obviously, there. And what has been the GAO's assessment of that scrutiny? " fcic_final_report_full--432 Commission focused thousands of staff hours on investigation, and not nearly enough on analyzing these critical economic questions. The investigations were in many cases productive and informative, but there should have been more balance be- tween investigation and analysis. Conclusions: • The credit bubble was an essential cause of the financial crisis. • Global capital flows lowered the price of capital in the United States and much of Europe. • Over time, investors lowered the return they required for risky investments. Their preferences may have changed, they may have adopted an irrational bub- ble mentality, or they may have mistakenly assumed that the world had become safer. This inflated prices for risky assets. • U.S. monetary policy may have contributed to the credit bubble but did not cause it. THE HOUSING BUBBLE The housing bubble had two components: the actual homes and the mortgages that financed them. We look briefly at each component and its possible causes. There was a housing bubble in the United States—the price of U.S. housing in- creased by more than could be explained by market developments. This included both a national housing bubble and more concentrated regional bubbles in four “Sand States”: California, Nevada, Arizona, and Florida. Conventional wisdom is that a bubble is hard to spot while you’re in one, and painfully obvious after it has burst. Even after the U.S. housing bubble burst, there is no consensus on what caused it. While we still don’t know the relative importance of the possible causes of the housing bubble, we can at least identify some of the most important hypotheses: • Population growth. Arizona, Florida, Nevada, and parts of California all expe- rienced population growth that far exceeded the national average. More people fueled more demand for houses. • Land use restrictions. In some areas, local zoning rules and other land use re- strictions, as well as natural barriers to building, made it hard to build new houses to meet increased demand resulting from population growth. When supply is constrained and demand increases, prices go up. • Over-optimism. Even absent market fundamentals driving up prices, shared expectations of future price increases can generate booms. This is the classic explanation of a bubble. • Easy financing. Nontraditional (and higher risk) mortgages made it easier for potential homebuyers to borrow enough to buy more expensive homes. This doesn’t mean they could afford those homes or future mortgage payments in the long run, but only that someone was willing to provide the initial loan. Mortgage originators often had insufficient incentive to encourage borrowers to get sustainable mortgages. FOMC20070807meeting--98 96,MR. KOHN.," Thank you, Mr. Chairman. Building on what the Vice Chairman just said, I have been listening in on that Morning Call. I’ve found it very useful, and it’s certainly an opportunity to ask questions if you have them. My forecast for the most likely outcome for output over the next few years is close to that of the staff—growth a little below potential for a few quarters, held down by the housing correction, and the unemployment rate rising a little further. Although some recent data for housing, consumption, and capital spending have been a bit to the soft side, we need to view those data against the background of a lower path for potential GDP and recall the tendency we’ve seen over the past several quarters for short runs of data that are a little hotter or a little cooler than we expected. I think this is sort of what it feels like when the economy is running at about 2 percent. I see a number of reasons to think that moderate growth remains the most likely outcome going forward. First, as President Stern has stressed from time to time, is the natural resilience of the economy, its tendency to grow near potential unless something is pushing it one way or another. If anything, this resilience has probably increased over the past couple of decades, reflecting more- flexible labor and product markets. Second, global growth remains strong, supporting the growth of exports. I don’t think this growth should be undermined by the fact that some unknown quantity of losses in the U.S. mortgage market is being absorbed by investors overseas, and the recent declines in the dollar will reinforce the effects of good foreign demand for U.S. goods and services. Third, the most likely factor to throw the economy off its potential is the financial markets. My most likely forecast assumed that the credit markets would begin to settle down over coming weeks with some, but limited, net tightening of conditions. I’ll return to the subject in a bit, but my outlook in this regard does rest fundamentally on the very strong financial condition of the nonfinancial business sector and commercial banks and my expectation that most households accounting for the vast bulk of consumer spending will not find credit availability newly constrained. Finally, a resumption of growth in consumption should be supported by moderate growth in jobs and household income as the rebound in productivity is limited by the slower path for trend productivity and as income shares shift a little toward labor. I also assumed that households would not face a repeat of the rise in gasoline prices that has taken something out of recent consumption demand. Then moderate growth in consumption along with good export markets should, in turn, support business investment spending. I expect this path for output to be associated with core inflation remaining in the neighborhood of 2 percent. If energy prices follow the path in futures markets, total inflation would come down to 2 percent as well. Basically I don’t see anything in my central tendency forecast for the economy that would push inflation very much one way or another. The economy produces around its long-run potential. My NAIRU was 4¾ percent. Inflation expectations as best we can judge are anchored at something like 2 percent PCE inflation. I’m encouraged that the most recent data on prices have tended to confirm that core inflation remains fairly low. Most measures of compensation also do not show a marked acceleration that might be associated with producing appreciably beyond the economy’s sustainable level of production. Risks around my inflation forecast remain to the upside, provided that output follows my most likely path. Utilization is tight. The recent run-up in energy prices could still feed through to expectations. The damped increase in productivity growth implies greater pressure on business costs and margins. Historically, nominal wages have tended to respond more sluggishly to changes in trend productivity than do prices, and this could be especially the circumstance when workers have seen real incomes held down by higher energy prices and business profit margins have been high. At the same time, like many around this table, I think that the downside risks around the forecast of moderate growth and production going forward have increased. For some time I thought that the risk of a shortfall from our central tendency outweighed the risk of an overshoot, mainly centered on housing and consumption. But the financial developments of the last intermeeting period have appreciably increased those risks. As many have remarked, and Bill said so nicely, problems have spread from the subprime sector to a good part of the mortgage market more generally, including a severe restriction on securitization of nonconforming mortgages. Some business credit has been affected. Spread are widening across a broad array of instruments and ratings. This has occurred in an atmosphere of greatly increased volatility and uncertainty, partly related to the questions about the pricing of complex structured credits that weren’t well understood and compounded by a loss of confidence in the rating agencies. The uncertainty is also a reflection of the perception that activity and prices in the housing market have not yet shown any signs of beginning to stabilize. I agree that we need to keep our focus on the effects of these developments and the financial markets on the economy, not on the distribution of wealth in the financial sector. The relationship of financial markets to real activity is multifaceted, not easily modeled with interest rates and stock prices, especially when markets are reconsidering risk. Tightening nonprice terms of lending, the reduced availability of credit, and simply the pervasive sense of uncertainty about the price of assets and cash flows can also affect spending. In such an environment, it wouldn’t be surprising if businesses and households postponed capital investments. I agree that this reassessment is a fundamentally healthy but somewhat messy correction to more-sustainable term and risk premiums. The most likely outcome is that it will be limited in duration and effect, and that’s what I assume for my forecast. Well-capitalized banks and opportunistic investors will come in and fill the gap, restoring credit flows to nonfinancial businesses and to the vast majority of households that can service their debts. In the end, credit conditions will be tighter than they were a little while ago, for the most part justifiably so, and the effect on output will probably not be very large. To be sure, the latest episode comes on top of a rise in term premiums over the May to June intermeeting period. As a consequence, financial conditions have tightened noticeably in the past few months, even abstracting from market disruptions of the last week. The federal funds rate has been as high as it has been in part to offset the accommodative effects of low volatility and tight term and credit premiums. I think that, even in the relatively benign adjustment scenario, we’ll need to look at whether that rate is still sufficiently supportive of economic activity. But in the circumstances—that is, the benign adjustment—that reassessment can await further information about aggregate demand and further assurance that inflation will remain low. I assumed an easing of policy in 2008 and 2009 in my projections to take account of this. But we can’t know how the market situation will evolve. I also believe that there’s a non-negligible chance of a prolonged and very messy adjustment period that would feed back substantially on confidence, wealth, and spending. With the rating agencies discredited and markets vulnerable to adverse news on the economy, the period of unusual uncertainty could be prolonged. The greatest risk is in the household sector, where uncertainty about valuations of mortgages could continue to feed back on credit availability, housing demand, and prices in a self-reinforcing cycle. Moreover, as lenders and borrowers revise assumptions about house prices even further, credit from home equity lines of credit and mortgage refinancings will become even less available and more expensive, putting to the test the hypothesis that I have been working under—that the feedback from housing on consumption can be approximated by a wealth effect, not something more serious working through housing equity withdrawal. As I noted, I don’t think this is the most likely outcome, but this tail of distribution is a lot fatter than it was only a month or so ago. Thank you, Mr. Chairman." CHRG-111hhrg56847--194 Mr. Bernanke," Well, first of all you did a good job of identifying some of the risks to the recovery: Financial market risks, small business credit, and unemployment. Those are some of the things that I have highlighted in speeches and discussions. As I have indicated, I think, once again, that we need to think about our fiscal path, our fiscal plan as a trajectory, not as a single year-by-year deficit. It is not realistic, I think, to--or even advisable to try to balance the budget this year because that would be too wrenching a change, and the economy is still in weak condition, and I don't think that would be possible or advisable. However, in order to maintain the confidence of the markets and to keep interest rates low, which is very useful for the whole economy and for the recovery, it is also very important to try to provide reassurance through some mechanism that Congress is seriously contemplating measures that will bring us back to sustainability over the medium term. I realize that is a difficult thing to do and it is difficult to be credible. But Congress is very creative on these types of matters and I hope that you will be looking at ways to find the path back to sustainability over the next few years. " CHRG-111hhrg52406--213 Mr. Bachus," Okay. Thank you. Mr. Miller of North Carolina. I like calling time on members who are much more senior than I am on this committee. We do need to try to get done before this series of votes. It is a real series of votes, not a temper tantrum of votes. For Ms. Keest and Mr. Plunkett, one series of questions, or one point repeatedly made today, is that consumer protection is a vague concept for which Congress should enact very bright line rules, which is somewhat contrary to the wisdom of previous generations. There was a famous 18th Century British case widely quoted in the United States that said that there should be no single, all-encompassing definition of ``fraud'' less the craft of men should find a way of committing fraud which might escape such a rule or definition. One of the principal functions of financial innovation in recent years appears to be to evade existing regulations. In your experience, Ms. Keest and Mr. Plunkett, how easy has it been to get legislation through Congress to protect consumers from financial practices? " CHRG-110shrg50369--100 Mr. Bernanke," That is right. Senator Bunning. That is considerable, and the market conditions indicated that that was absolutely necessary. " FOMC20081216meeting--292 290,MR. ROSENGREN.," A lot of these could go down quite substantially if conditions improve, and we wouldn't control that. " FOMC20081007confcall--37 35,CHAIRMAN BERNANKE.," Thank you. Other questions? All right. If not, let me just say a few words. I will be brief. It's more than obvious that we have an extraordinary situation. It is not a single market. It's not like the 1987 stock market crash or the 1970 commercial paper crisis. Virtually all the markets--particularly the credit markets--are not functioning or are in extreme stress. It's really an extraordinary situation, and I think everyone can agree that it's creating enormous risks for the global economy. What to do about it? The exchange we just had suggests that we may have disagreements about the benefits of liquidity provision. I personally think that it has been helpful. But I think we can agree that it is obviously not a panacea because, as the Vice Chairman points out, it doesn't address the underlying capital issues. That suggests that the right solutions probably have a significant fiscal element to them. However, one feature of the last few days is how striking, how uncoordinated, and how erratic some of the fiscal approaches have been--particularly in Europe, where there has been a remarkable lack of coordination in the European Union. So the fiscal solutions are coming, but they're not there yet, and it is going to be a while. We need greater clarity on those issues. We had a meeting today on the Treasury's authority, and they are hoping in the next few weeks to begin to provide greater clarity, which will be very helpful. But I think that, if we can find some kind of bridge, it would be helpful, and that's what this meeting is about. Although the financial markets are the dramatic element of the situation, I think we can make a case for easing policy today on the macro outlook, as given by Larry and Nathan. I won't go into detail. I think it's fairly clear. You look first at inflation, and you see the remarkable decline in commodity prices, the appreciation of the dollar, and the decline in breakevens. The 10-year breakeven this morning was about 1.35. Of course, that could be a noisy indicator, but certainly it's quite low. I would say that, in terms of activity and the relation to inflation, we don't have to rely on any flat Phillips curves here. We have a global slowdown, and the implications for commodity prices are first order for our inflation forecast. It is never safe to declare inflation under complete control, and I certainly don't claim that no risks are there; but clearly the outlook for inflation is not looking nearly so threatening as it may have in the past. On the economic growth side, what is particularly worrisome to me is that, before this latest upsurge in financial stress, we had already seen deceleration in growth, including the declines, for example, in consumer spending. Everyone I know who has looked at it--outside forecasters and the Greenbook producers here at the Board--believes that the financial stress we are seeing now is going to have a significant additional effect on growth. Larry gave some estimates of unemployment above 7 percent for a couple of years. So even putting aside the extraordinary conditions in financial markets, I think the macro outlook has shifted decisively toward output risks and away from inflation risks, and on that basis, I think that a policy move is justified. I should say that this comes as a surprise to me. I very much expected that we could stay at 2 percent for a long time, and then when the economy began to recover, we could begin to normalize interest rates. But clearly things have gone off in a direction that is quite worrisome. One could legitimately ask questions about the transmission mechanism under these conditions, and I think those are good questions. But first it seems to me that we can, to some extent, offset costs of credit through our actions, even if spreads are wide. Second, to the extent that the global coordination creates some more optimism about the future of the global economy, we may see some improvements in credit spreads. We may not, but it seems to me that this is the right direction in which to go. Despite everything that's happening, I might not be bringing this to you at this point, except that we have the opportunity to move jointly with five other major central banks, and I think the coordination and cooperation is a very important element of this proposal. First of all, again, I mentioned before the lurching and the lack of coordination among fiscal authorities and other governments. I think it would be extraordinarily helpful to confidence to show that the world central banks are working closely together, have a similar view of global economic conditions, and are willing to take strong actions to address those conditions. I think that there is a multiplier effect, if you will. Our move, along with these other moves, will have a stronger effect on the global economy and on the U.S. economy than our acting alone. Moving together has other benefits. Just to note one, we can have less concern about the dollar if we're all moving together and less concern about inflation expectations given that all the banks are moving and all see the same problem. There is a tactical issue. I think the real key to this is actually the European Central Bank. They have had some difficulty coming to the realization that Europe would be under a great deal of stress and was not going to be decoupled from the United States. They made an important rhetorical step at their last meeting to open the way for a potential cut, but I think that this coordinated action gives them an opportunity to get out of the corner into which they are somewhat painted and their move will have a big impact on global expectations about policy responsiveness. So, again, I think the coordination is a very important part of this. I want to say once again that I don't think that monetary policy is going to solve this problem. I don't think liquidity policy is going to solve this problem. I think the only way out of this is fiscal and perhaps some regulatory and other related policies. But we don't have that yet. We're working toward that. We are in a very serious situation. So it seems to me that there is a case for moving now in an attempt to provide some reassurance--it may or may not do so--but in any case, to try to do what we can to make a bridge toward the broader approach to the crisis. So that's my recommendation, that we join the other central banks in a 50 basis point move before markets open tomorrow morning. If we proceed in that direction, there are, as I mentioned, two statements. Brian, do the Presidents have the joint statement? " FOMC20071211meeting--11 9,CHAIRMAN BERNANKE., Thank you. Are there questions for Bill on financial conditions or for Bill or me on the TAF proposal? President Poole. FOMC20050202meeting--27 25,MS. BIES.," Mr. Chairman, I would just add one perspective on that, which relates to how businesses reacted when the Fed really started to bring inflation down in ’79, ’80, and ’81. One of the challenges that a lot of companies faced in that period was that they had gotten so accustomed to being able to raise prices automatically—because the climate was such that everybody was raising them—that the business processes around inflation anticipation were very different than what we have today. So to answer the question of whether low inflation is a desirable goal, one would have to look at it based on where we are today. Today I think companies understand that a major challenge in this very competitive environment is to find ways to enhance productivity. They realize that it’s a very tough world to operate in compared to the period of easy price increases that they might have experienced in the early ’80s. I think companies have learned that. So in today’s environment, since low inflation lowers the cost of capital and forces them to focus on service quality and their February 1-2, 2005 18 of 177 objective. But I think we would have heard a different answer from them if we had asked that in 1980." FOMC20080805meeting--124 122,MR. LACKER.," Thank you, Mr. Chairman. Before I begin, let me add my words of welcome to Betsy Duke, welcoming Governor Duke back to the Federal Reserve System. I say ""back"" because she has served excellently on our board of directors beginning almost 1 years ago. She's a fast friend and strong supporter of the Federal Reserve System. I'm delighted that the long wait for her installation is over, and I look forward to working with her; but I don't want any of my compliments to her to be detrimental to her effectiveness. [Laughter] The Fifth District economy has remained weak in recent weeks. Manufacturing and service sector activity fell. Real estate conditions remain sluggish. Labor markets remain soft. Export activity remains the bright spot, with reports of sustained growth in outbound cargo at District ports. In a new development, however, manufacturers' expectations for the very near future turned negative in our most recent survey. This is very unusual. Respondents are typically relatively optimistic about things six months from now. Retail contacts indicate that the decline in sales broadened in July in our survey, and there aren't many reports mentioning the effect of tax stimulus checks. Price expectations for both raw materials and final goods rose in our July survey, and some of those measures are at record highs. At the national level, my outlook for real growth is broadly consistent with the Greenbook's this time. I expect sluggish growth to continue through the remainder of the year, with a pickup beginning sometime next year. Housing is likely to continue to be a drag, though a diminishing one, until then. Consumer spending is likely to remain subdued, and business investment is likely to moderate somewhat. I expect payroll employment to continue to decline for a while at about the current pace--a pace that, as others have noted, is quite modest relative to what we typically see in a recession. I think the most likely outcome is for us to continue to skirt an outright recession. I think there is some risk of a broader and sharper contraction. I believe the magnitude of that risk is modest, but it's not negligible to me. Business investment could deteriorate, a risk that's most prominent in the nonresidential construction sector that we discussed earlier. But this is a small component of aggregate demand, smaller than housing; and given the nature of gestation lags in this sector, I think a downturn is likely to be gradual rather than abrupt. Household spending probably poses the greatest risk to growth at this point. Consumer spending has flattened out in real terms, although that's what one would expect given the increase in food and energy prices that we've seen. Given the difficulty of assessing the extent to which tax rebates are propping up consumer spending right now, we do not know how much Q4 consumption is going to be affected by the stimulus rolling off. Potential growth effects of credit constraints or financial headwinds have gotten a lot of attention these days. I remain skeptical about the magnitude of the drag on consumption and investment spending that credit market conditions are likely to create. We have, of course, seen reports in the Senior Loan Officer Opinion Survey of tightened credit terms, but through June both C&I and consumer loans have continued to grow. I would note that we are hearing in the Fifth District concerns from some of our smaller institutions that some large banks are bidding aggressively for deposits--this has been going on for several months now, of course--and as a result, the smaller banks are paying more to fund their loans. We're also hearing now--and this is a new report--of larger banks cutting back on fed funds lending to smaller institutions, no doubt out of a concern about possible bank failures. What I think we're seeing in banking markets is more of a reallocation of activity among banks. Different institutions have been affected very differently by recent events depending on the strategies they chose to pursue in the years preceding this episode. As a consequence, intermediation is just shifting from some institutions to others. In fact, we've heard of banks picking up business that other banks are shedding. Anecdotes about particular banks cutting back on lending thus need to be taken with a grain of salt, and I don't think they're necessarily representative of the banking sector as a whole. In fact, there was a really egregious case in the New York Times of people not getting credit from banks because of this credit crunch. In paragraph 6, one is introduced to their lead anecdote: a borrower at Wachovia who was denied credit. In paragraph 22, we find out that he actually got credit two weeks later at this same institution. So I'm a little skeptical about all of this anecdotal evidence about credit constraints. It's undoubtedly the case that credit standards have tightened, but the environment is such that a lot of borrowers have gotten genuinely weaker. I mention all of this just because it influences how I feel about arguments that credit market conditions make the current level of the real funds rate any less meaningful as an indicator of the stance of monetary policy. I just don't find those arguments convincing right now. The real funds rate using the Greenbook's forecast of overall inflation four quarters ahead is lower than it has been at any time since the 1970s. In fact, this measure is about 1� percentage points lower than the lows it reached in 2003 or 1994, and I think this is to my mind a better way to measure the actual real federal funds rate than what's plotted in the Bluebook. The Greenbook forecast is that core PCE inflation will rise to 2.6 percent for the second half of this year and then gradually subside to 1� percent a year or so after that. This forecast is a very risky path, I believe, because at any point along that hump, higher inflation could well become embedded in expectations. I think getting back to price stability after this episode is going to depend critically on the stability of inflation expectations, as many of you have noted. It is true that TIPS compensation measures have been reasonably steady for a few months and that wage rates show no sign of accelerating as yet. But if we wait to raise rates until wage rates accelerate or TIPS measures spike, we will have waited too long. I think that's very clear, and it will cost us too much to recover our credibility. Accordingly, I believe that the biggest policy risk we're going to be facing in the months ahead is the risk of waiting too long. In past episodes of economic or financial weakness, we've been unwilling at times to raise the funds rate until we were almost completely certain that economic recovery would be sustained. I do not think that we can afford that luxury at the present time. The risk is too great that inflation expectations will ratchet up again. We need to be prepared to raise rates even if growth is not back to potential and even if financial markets are not yet tranquil, and we need to be prepared to raise rates even if we think that we might have to reverse course. After all, we cut rates aggressively even though we were not certain that a recession was in store for us and, in part, on the grounds that we could reverse course if it proved that we cut too far. To insist on more certainty to raise rates than to reduce them would introduce a fatal asymmetry in our reaction function. Let me add a comment or two inspired by some of the discussion around the table. I want to commend President Bullard's discussion of systemic risk. You mentioned this earlier in your Q&A session, Mr. Chairman. This is a notoriously slippery concept. In popular usage, it seems to mean an episode in which one bad thing happens followed by a lot of other seemingly related bad things happening, and as such, it's a purely empirical notion without any content or usefulness by itself as a guide to policy. It doesn't say whether those other bad things are efficient--things that ought to happen--or inefficient and preventable by suitable policy intervention. To invoke the notion of systemic risk to support a particular policy course requires theory. I spoke about theory last night, but it requires some theory, some coherent understanding of the way you think the world works. The theoretical literature related to systemic risk is relatively young, and this isn't the place to go into it. I've said before that I think it would be useful for this Committee to learn more about this. The Committee might be surprised that the literature provides only relatively tenuous rationales--I think is a fair judgment--for policy intervention. I hope, Mr. Chairman, that the group you've commissioned to study the meaning of unusual and exigent circumstances can explore this terrain in a little more depth. Going forward, I think our deliberations would be aided if we were to strive to put our theoretical frameworks on the table when discussing how financial markets work and what we ought to do about them. In case there's any suspense, for my own money--and this is just one man's view--I haven't seen a convincing case for the existence of policy-relevant market failures in the financial markets in which we've intervened, apart from the usual distortions owing to the federal financial safety net. We systematically expanded that safety net. I believe what we've done has been to subsidize selected borrower classes and prop up prices of various financial assets, and I think the problem we face now is the tremendous dependency of financial institutions and markets on our credit. Thank you. " CHRG-111shrg57319--218 Mr. Schneider," Chairman Levin, Dr. Coburn, and Members of the Subcommittee, thank you for the opportunity to appear before you today. My name is David Schneider.--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Schneider appears in the Appendix on page 158.--------------------------------------------------------------------------- Beginning in July 2005, I served as President of Washington Mutual's Home Loan Business, which originated prime mortgage loans. In 2006, I was given the additional responsibility for Long Beach Mortgage Company, which was WaMu's subprime lending channel. Before I arrived at WaMu, its management and Board had adopted a lending strategy for the coming years. I understood that its strategy was intended, at least in part, to reduce WaMu's exposure to market risk, that is, its exposure to interest rate changes. WaMu planned to do so by shifting the assets it held on its balance sheet away from market risk towards credit risk, for example, by holding more adjustable-rate mortgages. This strategy was called a higher-risk lending strategy and would have been implemented through the bank's Asset and Liability Committee. ALCO made decisions on which loans to hold and which to sell based on the loans' risk-return profile and other relevant issues, including the type and geographic location of the loans WaMu already had on its books. Although WaMu intended to change its business strategy, market conditions soon caused WaMu to go in another direction. As house prices peaked, the economy softened, and credit markets tightened, WaMu adopted increasingly conservative credit policies and moved away from loan products with greater credit risk. WaMu increased documentation requirements, raised minimum FICO scores, lowered LTV ratios, and curtailed underwriting exceptions. My team also enhanced WaMu's fraud detection programs. During my time at WaMu, we reduced and then entirely stopped making Alt A loans and Option ARM loans. Alt A lending ended in 2007. Option ARM loans decreased by more than a half from 2005 to 2006, and by another third from 2006 to 2007. WaMu stopped offering Option ARM loans altogether at the beginning of 2008. When the subprime lending operation at Long Beach was placed under my supervision in 2006, I was asked to address the challenges its business presented. During that year, I changed Long Beach management twice. As I became more familiar with Long Beach Mortgage, I concluded that its lending parameters should be tightened, so across various loan products we raised FICO scores, lowered LTV ratios, established maximum loan values, increased documentation requirements, improved programs to detect and prevent fraud, and in 2007 eliminated stated income lending. As a result, the percentage of approved Long Beach loans that were based on full documentation increased every year I oversaw Long Beach, and the percentage of loans with combined LTV ratios greater than 90 percent decreased every year over that same period. More broadly, WaMu eliminated many subprime products and then stopped originating subprime loans entirely. As a result, WaMu's subprime lending declined by a third from 2005 to 2006 and by 80 percent from 2006 to 2007. When I began my job at Washington Mutual, my goal was to evaluate and improve our home lending efforts in all respects. As market changes began to change, my team and I worked very hard to adapt to the new conditions and at the same time address the challenges WaMu faced. During the time I was President of Home Loans, we acted to reduce the size and associated risk of the Home Loans business. Specifically, we closed its broker and correspondent lending channels. We closed Long Beach Mortgage. We eliminated a number of higher-risk loan products and bolstered quality controls through tightening credit standards, improving the automated underwriting tools, enhancing fraud detection and prevention, and curtailing underwriting exceptions. I hope this brief summary has been helpful and I look forward to your questions. Thank you. Senator Levin. Thank you very much, Mr. Schneider. Mr. Beck. TESTIMONY OF DAVID BECK,\1\ FORMER DIVISION HEAD OF CAPITAL CHRG-111hhrg52261--109 Mr. Hampel," Thank you. Chairwoman Velazquez, Ranking Member Graves, and other members of the committee, thank you very much for the opportunity to testify at today's hearing on behalf of the Credit Union National Association, which represents over 90 percent of our Nation's 8,000 State and Federal credit unions, the State leagues, and their 92 million members. I am Bill Hampel, the Chief Economist. Credit unions did not contribute to the recent financial debacle, and their current regulatory regime, coupled with their cooperative structure, militates against credit unions ever contributing to a financial crisis. As Congress considers regulatory restructuring, it is important that you not throw out the baby with the bathwater. Regulatory restructuring should not just mean more regulation. There needs to be recognition that in certain areas, such as credit unions, regulation and enforcement is sound and regulated entities are performing well. Credit unions have several concerns in the regulatory restructuring debate. These include the preservation of the independent regulator, the development of the CFPA, and the restoration of credit unions' ability to serve their business-owning members. First, it is critical that Congress retain an independent credit union regulator. Because of credit unions' unique mission, governance, and ownership structure, they tend to operate in a low-risk, member-friendly manner. Applying a bank-like regulatory system to this model would threaten the benefits that credit unions provide their members. There is some logic for consolidating bank regulators where competition can lead to lax regulation and supervision, but that condition does not exist for credit unions which have only one Federal regulator, the National Credit Union Administration. The general health of the credit union system proves that our system works well. Considering the CFPA, consumers of financial products, especially those provided by currently unregulated entities, do need greater protection. CUNA agrees that a CFPA could be an effective way to achieve that protection, provided that the agency does not impose redundant or unnecessary regulatory burdens on credit unions. In order for a CFPA to work, consumer protection regulation must be consolidated and streamlined to lower costs and improve consumer understanding. CUNA strongly feels that the CFPA should have full authority to write the rules for consumer protection, but for currently regulated entities, such as credit unions, the examination and enforcement of those regulations should be performed by the prudential regulator that understands their unique nature. Under this approach, the CFPA would have backup examination authority. CUNA urges Congress to take the difficult step of preempting State consumer protection laws if establishing a CFPA. We are confident that by creating a powerful Federal agency with the responsibility to regulate consumer protection law, with rigorous congressional oversight, more than adequate consumer protection will be achieved. And if the CFPA is sufficiently empowered to ensure nationwide consumer protection, why should any additional State rules be necessary? Conversely, if the proposed CFPA is not expected to be up to the task, why even bother establishing such an agency in the first place? Finally, because they are already significantly regulated at the State level, we don't believe that certain types of credit life and credit disability insurance should be under the CFPA. As Congress considers regulatory restructuring legislation, CUNA strongly urges Congress to restore credit unions' ability to properly serve the lending needs of their business-owning members. There is no economic or safety and soundness rationale to cap credit union business lending at 12.25 percent of assets. Before 1998, credit unions faced no statutory limit on their business lending. The only reason this restriction exists is because the banking lobby was able to leverage the provision when credit unions sought legislation to permit them to continue serving their members. The credit union business lending cap is overly restrictive and undermines America's small businesses. It severely limits the ability of credit unions to provide loans to small businesses at a time when these borrowers are finding it increasingly difficult to obtain credit from other types of financial institutions, as was described by Mr. Hirschmann from the U.S. Chamber in the previous panel. It also discourages credit unions that would like to enter the business lending market from doing so. We are under no illusion that credit unions can be the complete solution to the credit crunch that small businesses face, but we are convinced that credit unions should be allowed to play a bigger part in the solution. Eliminating or expanding the business lending cap would allow more credit unions to generate the portfolios needed to comply with NCUA's regulatory requirements and would expand business loans to many credit union members, thus helping local communities and the economy. Credit unions would do this lending prudently; the loss rate on business loans at credit unions is substantially below that of commercial banks. A growing list of small business and public policy groups agree that now is the time to eliminate the statutory credit union business cap for credit unions. And in July, Representatives Kanjorski and Royce introduced H.R. 3380, the Promoting Lending to America's Small Business Act, which would increase the credit union business lending cap to 25 percent of total assets and change the size of a loan to be considered a business loan. We estimate that credit unions could safely and soundly lend an additional $10 billion in small loans in the first year after enactment of such a bill. Madam Chairwoman, thank you very much for convening this hearing, and I look forward to answering the committee's questions. " FOMC20080916meeting--158 156,CHAIRMAN BERNANKE.," Thank you very much, and thanks, everyone, for very helpful comments. Let me try to summarize, and I will just make some comments, and then we can turn to the statement and policy. The group indicated, of course, that economic growth has slowed and looks to be quite sluggish in the second half. I didn't hear a great deal of change in the general profile, with most people still viewing growth as being slow in the near term but perhaps recovering somewhat in 2009. But obviously there is a lot of uncertainty surrounding that judgment. The ongoing problems in housing and the financial system are, of course, the downside risks to growth. Another factor, which is becoming more relevant, is the slowing global economy, which together with the stronger dollar may mean that U.S. export growth will be somewhat less. Despite the tax rebate, consumer spending seems likely to be weak in the near term, reflecting a variety of factors that we noted before, including housing and equity wealth, credit conditions, and particularly perhaps the ongoing weakness in the labor market. The labor market is deteriorating, with unemployment up, although UI programs may play some role in the unemployment rate. It is somewhat difficult to predict the peak of the unemployment rate, given the upward momentum we are seeing. Declines in energy prices, however, will improve real incomes and help consumer sentiment--so that is a potentially positive factor. The housing sector continues to be the central concern in the economy, in both the real and the financial sides. There are no clear signs of stabilization, although obviously regional conditions vary considerably. The government action regarding the GSEs has lowered mortgage rates and may be of some assistance. Credit conditions have tightened, though, in other areas as well, including nonresidential construction. Firms are continuing to struggle with weaker demand, higher uncertainty, and high costs. Manufacturing has been relatively stable to weaker, but we had at least one report of a survey that in the medium term the outlook is looking a little better. Inventories appear to be relatively well managed. Credit conditions for business vary, but there are indications that some firms are finding it very difficult to attract capital. Financial markets received a lot of attention around the table. Conditions clearly have worsened recently, despite the rescue of the GSEs, the latest stressor being the bankruptcy of Lehman Brothers and other factors such as AIG. Almost all major financial institutions are facing significant stress, particularly difficulties in raising capital, and credit quality is problematic, particularly in residential-related areas. One member noted that it is not evident that markets are clearly differentiating between weaker and stronger firms at this point. Deleveraging is continuing, and securitization markets are moribund. Credit terms and conditions are quite tight and may be a significant drag on the economy. However, the mediumterm implications of the recent increases in financial stress for the economy are difficult to assess. We may have to wait for some time to get greater clarity on the implications of the last week or so. On the inflation front, recent core and headline numbers have been high, reflecting earlier increases in the prices of energy and raw materials. There are positive factors, including the significant intermeeting declines in the prices of oil and other commodities, which, if maintained, would bring headline inflation down rather notably by the end of the year or next year. The dollar has also strengthened. Generally speaking, inflation expectations, though noisy, have improved. We have seen a decline in TIPS breakevens and some decline in survey expectations as well. But it was noted that the five-by-five TIPS breakeven remains above a level consistent with long-term price stability. Nominal wage growth has remained subdued so far, slack is increasing, productivity has been strong, and therefore, unit labor costs are well controlled. Again, all of these factors are positive in terms of a better inflation picture going forward. On the other hand, recent declines notwithstanding, the cumulative increases in commodity prices over the past year or so do remain large, and there is some evidence that these cost increases are being passed through into core prices. Commodity prices are extremely volatile, which makes inflation very difficult to forecast and makes the inflation outlook, therefore, quite uncertain. Wages could also begin to rise more quickly as the economy strengthens. For all these reasons, inflation risks are still in play and remain a concern for the Committee. Some participants reiterated their concern that maintaining rates too low for too long risks compromising our credibility and stimulating inflation over the medium run. That is a very quick survey of the comments. Are there any comments or questions? If not, let me just make a few comments. Personally, I see the prospects for economic growth in the foreseeable future as quite weak, notwithstanding the second quarter's strength. I think what we saw in the recent labor reports removes any real doubt that we are in a period that will be designated as an official NBER recession. Unemployment rose 1.1 percentage points in four months, which is a relatively rapid rate of increase. The significance of that for our deliberations is, again, that there does seem to be some evidence that, in recession regimes, the dynamics are somewhat more powerful and we tend to see more negative and correlated innovations in spending equations. So I think that we are in for a period of quite slow growth. That is confirmed by what we are seeing in consumption, which probably would be quite negative if it weren't for the remainder of the fiscal stimulus package. Other components of demand are, likewise, quite weak. We are all familiar with the housing situation. Some other factors that were supportive in Q2 are weakening--a number of people have noted the export growth. Actually, it is net exports--which is important--not just exports, and we are seeing both slowing growth in exports and some forecast of increased growth in imports. A factor that we haven't talked about much is the fiscal side. That has been supportive and may be less supportive going forward. Generally speaking, though, I do think--and I have said this for a long time--that the credit effects will be important. They operate with a lag. It is very difficult to judge the lag. But my strong sense is that they are still some distance from their peak; that they will begin to be felt outside of housing, in nonresidential construction, for example, in consumer spending, and in investment; and that this is going to be independent of last week's financial developments. I think that is going to be a major drag, probably well into next year. There are a few positives, which give some hope of some improvement next year. We have talked about energy and commodity prices as they relate to inflation, but of course, the decline in energy and commodity prices is also a plus for consumers and raises real incomes and would be supportive of sentiment, as we have already seen. There are a few positive indications here and there on the housing market, a few glimmers of stability, particularly in some regions. I think that the GSE stabilization is going to be very important. It has already lowered mortgage rates. It suggests that there will be a market for securitized mortgages, and I think that is positive. So if I wanted to outline an optimistic scenario, it would involve stronger indications of stabilization in housing, which in turn would feed into more confidence in the financial sector and would lead over time to improvement in the broader economy. I do think that financial conditions are a major concern. The situation right now is very uncertain, and we are not by any means away from significant systemic risk. Even if we avoid a major systemic event, the increase in risk aversion, the pullback from all counterparties, the deleveraging, the sale of assets--all of these things are going to continue for some time and are going to make the financial sector very stressed, which obviously will have effects on the economy. I have been grappling with the question I raised for President Lacker, and I would be very interested in hearing other views either now or some other time. The ideal way to deal with moral hazard is to have in place before the crisis begins a well-developed structure that gives clear indications in what circumstances and on what terms the government will intervene with respect to a systemically important institution. We have found ourselves, though, in this episode in a situation in which events are happening quickly, and we don't have those things in place. We don't have a set of criteria, we don't have fiscal backstops, and we don't have clear congressional intent. So in each event, in each instance, even though there is this sort of unavoidable ad hoc character to it, we are trying to make a judgment about the costs--from a fiscal perspective, from a moral hazard perspective, and so on--of taking action versus the real possibility in some cases that you might have very severe consequences for the financial system and, therefore, for the economy of not taking action. Frankly, I am decidedly confused and very muddled about this. I think it is very difficult to make strong, bright lines given that we don't have a structure that has been well communicated and well established for how to deal with these conditions. I do think there is some chance--it is not yet large, but still some chance--that we will in fact see a much bigger intervention at the fiscal level. One is tempted to argue that by doing more earlier you can avoid even more later, but of course that is all contingent and uncertain. So we will collectively do our best to deal with these very stressful financial conditions, which I don't think will be calm for some time. With respect to inflation, I accept the many caveats around the table. I have to say that I think, on net, inflation pressures are less worrisome now. The last two meetings have been very positive in that respect. The declines in energy and commodity prices are quite substantial. Natural gas, for example, has reversed all of its gains of the year. Steel scrap is down 40 percent in two months. We are seeing many other indications that commodity prices really have come down quite a bit. The dollar's increase is also quite striking, and we have talked about wages, TIPS, and other factors. So I think overall I see at least the near-term inflation risk as considerably reduced. I do agree, though, with the points that were made that we may well see pressure on core inflation for a while longer, despite this morning's reasonably benign number. The increases in commodity costs, although they have been partially reversed, have not been entirely reversed. Certainly over the last year to year and a half there is still a net substantial increase, which will show up as firms begin to pass through those costs. It is also the case, of course, that we have seen a very, very sharp movement in commodity prices and the dollar. Therefore, there is no logical reason why that couldn't be reversed. Clearly, one problem we face is that the uncertainty about forecasting commodity prices is so large that it makes our forecasting exercises extraordinarily uncertain and means that we need to be somewhat more careful than we otherwise would be if we were back in the days of the Texas Railroad Commission, when we knew the price of oil six months in advance. We don't have that privilege anymore. So I think core inflation may be elevated for a while. It may take a while for inflation to moderate. Everything I say is contingent on the dollar and commodity trends not being strongly reversed. But if those things are not reversed, I think we will see some improvement in inflation in the near term. I also agree with those who say that, when the time comes, we do need to be prompt at removing accommodation. It is just as much a mistake to move too late and allow inflation, and perhaps even financial imbalances, to grow as it is to move too early and be premature in terms of assuming a recovery. I think that is a very difficult challenge for us going forward, and I acknowledge the importance of that, which a number of people have noted. So that is a quick summary of my views. Let me just turn briefly, then, to policy. Do we have the statement? Let me just preview. I talked with Governor Warsh, and he gave me now during the break some of those suggestions he made. As they fit closely with other things that people said around the table, we have made a version here that incorporates them. I'll discuss that in just a minute. 3 First, as a number of people have said, let me just say that I thought the memo that the staff prepared over the intermeeting period was extraordinarily helpful. We have been debating around the table for quite a while what the right indicator of monetary policy is. Is it the federal funds rate? Is it some measure of financial stress? Or what is it? I think the only answer is that the right measure is contingent on a model. As President Lacker and President Plosser pointed out, you have to have a model and a forecasting mechanism to think about where the interest rate is that best achieves your objectives. It was a very useful exercise to find out, at least to some 3 The statement referred to here is appended to this transcript (appendix 3). extent, how the decline in the funds rate that we have put into place is motivated. In particular, the financial conditions do appear to be important both directly and indirectly--directly via the spreads and other observables that were put into the model and indirectly in terms of negative residuals in spending equations and the like. The recession dynamics were also a big part of the story. I hope that what this memo does for us--again, I think it's extraordinarily helpful--is to focus our debate better. As President Plosser pointed out, we really shouldn't argue about the level of the funds rate or the level of the spreads. We should think about the forecast and whether our policy path is consistent with achieving our objectives over the forecast period. I am sympathetic to the general view taken by the staff, which argues that those recession dynamics and financial restraints are important, that we are looking at slow growth going forward, and that inflation is likely to moderate. Based on those assumptions, I think that our policy is looking actually pretty good. To my mind, our quick move early this year, which was obviously very controversial and uncertain, was appropriate. Their analysis also suggests that the amount of insurance that we have is perhaps limited, given that they take a risk-neutral kind of modeling approach. Having said that, I think they have also clearly set out the conditions and the framework in which we can debate going forward exactly where we should be going. To the extent that those around the table disagree with the model or with the projection, then that is the appropriate way, it seems to me, to address our policy situation. So, again, I do very much appreciate that. It helped me think about the policy situation. As I said, I think our aggressive approach earlier in the year is looking pretty good, particularly as inflation pressures have seemed to moderate. Overall I believe that our current funds rate setting is appropriate, and I don't really see any reason to change. On the one hand, I think it would be inappropriate to increase rates at this point. It is simply premature. We don't have enough information. There is not enough pressure on inflation at this juncture to do that. On the other hand, cutting rates would be a very big step that would send a very strong signal about our views on the economy and about our intentions going forward, and I think we should view that step as a very discrete thing rather than as a 25 basis point kind of thing. We should be very certain about that change before we undertake it because I would be concerned, for example, about the implications for the dollar, commodity prices, and the like. So it is a step we should take only if we are very confident that that is the direction in which we want to go. Therefore my recommendation to the Committee--and I will open it up for comment in a moment--is to keep the funds rate at its current level. I listened very carefully to the conversation around the table in terms of the statement. I think it was President Lockhart, President Stern, and Governor Warsh, among others, who talked about strengthening the language on financial markets. So the draft statement that you have in front of you is an attempt to make that change. It has two changes relative to existing alternative B. First, as Governor Warsh suggested, it reverses the first two sentences and so focuses in the first sentence on ""Strains in financial markets have increased significantly and labor markets have weakened further,"" and then the rest of it is basically the same as it was. The other change, which is in the last paragraph in the risk assessment, is pretty small, but it is probably worth considering. The word ""closely"" has been added to suggest, obviously, that we understand that the situation is changing rapidly and that we are carefully following conditions as they evolve. Kevin, we took your word ""market"" there--what was the rationale for it? " fcic_final_report_full--370 I nvestments i n Money Mar k et F unds In a flight to safety, investors shifted from prime money market funds to money market funds investing in Treasury and agency securities. IN TRILLIONS OF DOLLARS, DAILY $2 1 . 5 1 . 5 0 P r i me T reasury and government AUG . 2008 S EPT. OC T. SOURC E: Crane D ata Figure . anecdotally that the dealers weren’t even picking up their phones. The funds had to get rid of their paper; they didn’t have anyone to give it to,” McCabe said.  And holding unsecured commercial paper from any large financial institution was now simply out of the question: fund managers wanted no part of the next Lehman. An FCIC survey of the largest money market funds found that many were unwilling to purchase commercial paper from financial firms during the week after Lehman. Of the respondents, the five with the most drastic reduction in financial commercial paper cut their holdings by half, from  billion to  billion.  This led to unprecedented increases in the rates on commercial paper, creating problems for borrowers, particularly for financial companies, such as GE Capital, CIT, and American Express, as well as for nonfinancial corporations that used commercial pa- per to pay their immediate expenses such as payroll and inventories. The cost of commercial paper borrowing spiked in mid-September, dramatically surpassing the previous highs in  (see figure .). “You had a broad-based run on commercial paper markets,” Geithner told the FCIC. “And so you faced the prospect of some of the largest companies in the world and the United States losing the capacity to fund and access those commercial paper markets.”  Three decades of easy borrowing for those with top-rated credit in a very liquid market had disappeared almost overnight. The panic threatened to disrupt the payments system through which financial institutions transfer trillions of dollars in CHRG-111hhrg48674--351 Mr. Bernanke," Well, there are a lot of issues there. They did have zero interest rates; in fact, they still have essentially zero interest rates. I do think that speed of response is very important. As you have all experienced firsthand politically, it is not easy to bring the public along to try to address problems in the banking system. And in Japan the political resistance was one of the reasons why it took a very long time to address the problem. American people have complained a lot, and I don't blame them. On the other hand, I think people understand that something needs to be done, and these steps that are being taken, as distasteful as they are in some cases, are essential. And I think it speaks well of the Congress that you did act to take these steps, and that we are moving in a reasonably expeditious way, given the speed of events and all that has happened, to begin to tackle our problems. We are much better off addressing them quickly than letting them fester. Ms. Bean. Thank you. I have a few other questions. One is you have spoken before about the use of tax dollars, both some that have involved congressional involvement with TARP, and some of the things you have been able to do without our involvement to stabilize our system. We have also spoken to the fact that the government has the unique ability to hold certain assets that may presently be illiquid and undervalued until a point when we might get a better return on those dollars. How much has that picture changed, in your mind, from when you testified in the past about how much of that is likely to come back? Are you feeling better, worse moving forward? Are you going to have to hold onto certain things longer? What is your feeling? " FinancialCrisisInquiry--182 Can you turn your mic on, Mr. Rosen? ROSEN: I’m Ken Rosen. I want to thank Chairman Angelides and Vice Chairman Thomas, and the commission for having me here. I want to not read my testimony since you have it. But I’m going to talk a little bit about what I think is the epicenter of the crisis—where this started, how it got there, and where we are today, which is the housing market—the housing and residential mortgage market. Excessively easy credit, extremely low interest rates created a house price bubble. And the house price bubble when it burst has really caused a significant part of the problems that we had—at least the—initially. And of course it caused—helped cause the great recession where we have lost over eight million jobs. I think the most important thing to say is how did we get here. And I would say that low interest rates is part of the blame, but really it’s the poorly structured products that came about in this environment. Innovative products are important, and a good thing. And I’ve written papers on—on this in the 1970s and 80s while we needed innovative mortgage products. And they’re good for some people—some households. Subprime— there is a need for having that. But not to the market share it got. Low down payment loans – Alt-A loans, option arms. All those made some sense for a portion of the population. What happened is we layered all these risks. We went from a conservatively written subprime loan to a subprime loan that had no down payment, and didn’t document someone’s income or employment. So we made a mistake from what was a good idea by financial institutions became a bad idea for the entire overall market. And then we combine that with a second component which was I thought bad underwriting. We lowered underwriting standards dramatically. We started this in California, and it spread everywhere. We—we do this sometimes. Liars loans which are stated income loans, and there was rampant fraud at the consumer level. We’ve heard discussion of this at the institutional level, but I think the consumer basically really did this so they could qualify for the loan. There was some complicity on the part of brokers and originators. I think—I do not think this was at the high level institutions, but it’s at the individual originator level. CHRG-110shrg50420--67 Mr. Kepplinger," As you asked before and as you pointed out, the conditions in the Chrysler loan guaranty statute were very specific. Congress, I think, developed these conditions through over about a three or 4-month period, and I suspect, without really knowing, that there was general acceptance by the major players before the legislation was passed. Now, there was a series of findings that the Chrysler loan guaranty board had to make as a condition for issuing a commitment--viability, ability to repay, assurances that the concessions were in place, a financing and operating plan that was satisfactory to the board, because actually, as Gene has pointed out before, it is one of the best protections for the government is to assure that the government has confidence in the financing and operating plans going forward. Then in addition to that, at the time of the loan guaranty, there were other assurances and requirements that had to be in place--guaranty fees, warrants, other protections, financial upside advantage for the government should it happen, positions in the event of bankruptcy, a senior position, et cetera, et cetera, et cetera. I can supply, if you would like, a fairly detailed and perhaps more orderly recitation of what they were. Senator Crapo. That would be very helpful. I note I am way over my time. I apologize to the Chairman for that. I would just like to ask one quick follow-up. In terms of these kinds of conditions that Congress imposed, and I would like those specifics, would the oversight board that we are contemplating that you are talking about today, would it have authorities to engage in management decisions on behalf of the companies? " CHRG-110shrg50420--255 Mr. Mulally," Yes, I am happy to comment on it. We started by looking at history through all the economic cycles, especially around 1980, and looking at the peak to trough on the contraction of the economy and then the recovery coming out. And the scenarios that you asked us for really we believe bracketed what we think that economic scenario would look like. And it is pretty much in agreement with what the Federal Reserve just announced a few days ago about the contraction next year being in the 1 to 1.5 percent. So we have the economy contracting all the way through 2009 and not starting to recover until 2010. And I really, our economists, everybody we are talking to really believes that with the actions that we are taking today on the fiscal and the monetary policy and the stimulus that you are thinking about, that that is a very, very conservative recovery. The other scenario you asked for, which was a kind of worst case, would be an economy contraction that we have never seen before since the Depression. So I think that middle scenario that you asked for is a very conservative, realistic scenario, and that is what we based on request for a potential need of the $9 billion. So we think that is a good number. Senator Menendez. Well, let me just say there is--I understand that answer. There is a gulf between $34 billion, which grew from $25 billion, which is what we were told was necessary for viability, to $75 to $125 billion. And my concern is getting our arms around this in a way that we know the totality of the situation and can meet with--I mean, none of you could operate--well, if you operate a company like this, you are not going to succeed. If we operated as fiduciaries to the taxpayers like, we cannot succeed. It is what has happened at the TARP program where we are throwing money out there without having a sense of the strategy of understanding what is necessary in this case to assure viability. Let me ask two final questions. Are you all committed truly--and you will have to be committed because, as far as I am concerned, there are going to have to be conditions placed--to the type of fundamental transformational change that is necessary for you to survive? Are you truly committed--you know, Mr. Wagoner, Saturn was your previous commitment to that, and then you largely walked away. You know, so that is a past example. You know, are you truly committed to that? And, last, can you tell us, of those groups that are out there that already see taxpayer bailout funds, how many of them are holding a good part of your commercial debt? The final comment I will make, I just want to say, President Gettelfinger, you know, leadership is really tested in difficult times, and I appreciate what you have been willing to do to come forward. And it is never easy for a union leader to come forth and make very serious concessions and even talk about getting to the table more. But it cannot be done simply by the union. There have to be all the elements here to achieve the goal--the suppliers, the creditors, and others. Otherwise, the union cannot solve this problem on their own, and I know some would like to break the back of the union here as part of their goal. But this is not going to be achieved just simply through that. Could you just answer those questions? " CHRG-111hhrg56776--181 Mr. Bernanke," If we are the consolidated supervisor, then it's our responsibility, and we need to do a good job to do that. But, of course, there are lots of things to look at. I have to say, in the case of Lehman, it was pretty clear that they were in weak condition, independent of this particular piece of accounting. " CHRG-110hhrg38392--24 The Chairman," Well, my time has expired. I just want to say that I would urge people to read this report. And I think, first of all, debunking by Mr. Slaughter who served on the Council of Economic Advisors, I believe under your chairmanship, along with you as a colleague, Grant Aldonas, they say that education is a good thing, but being made to tow too much weight. But here is the problem, even with education. Getting people that education requires, to a great extent, some public participation. We can't expect the private sector to pay for this out of what it does. And this is another factor. As long as we have the current situation in which government is considered to be a bad thing, etc.--let me put it this way: The way in which we finance education in the country today, particularly beyond K-12, reinforces inequality, it doesn't alleviate it. So yes, education properly done could do this. But kind of oh, well, that is the way the world is and we will just have to hope for the better, is a problem. The notion that a stable economy, and this is where I think, again, we have a fundamental difference, yes, I would like to see a strong, stable economy. That is a necessary condition for diminishing inequality. But it is clearly an insufficient condition, and in the absence of any recognition of that, you are going to continue to see the kind of gridlocking in which trade promotion and immigration and other issues don't go anywhere. I just urge people who want to see us move in this direction to help us diminish inequality, or you will have continued economic gridlock. The gentleman from Alabama. " FOMC20070918meeting--126 124,MR. WARSH.," Thank you, Mr. Chairman. As Governor Kohn just suggested, I think financial market tumult is likely to be of sufficient duration to have a meaningful effect on the real economy. The policies that we’ll be considering later today are unlikely to be a panacea, but I think that is not a reason for us to avoid taking some smart and preemptive actions. The recuperation of these financial market trends is positive, but I wouldn’t measure the recovery period here in weeks or even the next couple of months. I suspect it is going to take longer. The moderate growth story that many of us have been telling and that is reflected in the Greenbook and has been for some time appears at best case to be even more moderate. The downside risks and the possibility of some nonlinear events in these financial markets are higher, perhaps not as high as they might have seemed when we last met by videoconference, but those prospects are still very real. When we had the videoconference on August 16, there appeared to be at that moment extremely poor market functioning, necessitating our actions that day. I think we rightly determined that there was a liquidity shock, maybe even a liquidity crisis, that was affecting financial intermediaries and that our actions were necessary to stop the liquidity symptoms from manifesting themselves as a credit crisis. To that end, our work goes on today. The results from that action and the benefit of time seem to have stopped the bleeding, and the deterioration of financial market conditions has largely ceased. However, although the improvements at this point are quite encouraging, I don’t think they are yet convincing. Let me just spend a few moments on the distinct phases of what this financial market distress has looked like and try to outline, maybe even oversimplify, where we are in that. Phase 1 strikes me as liquidity replenishment by financial institutions and marketmakers alike. During the past three to four weeks, commercial banks, investment banks, asset managers, and other private pools of capital have had to reassess their liquidity needs, their cash needs, in light of the tougher financial market conditions. Today, by and large, they have more cash on hand than they ever thought would be necessary or prudent. But that liquidity replenishment, at least for the median and stronger firms, is somewhat complete as they evaluate what the risks are of contingent liabilities coming on their balance sheets and as they reevaluate the stress tests and the comments of the people and the risk managers who had been telling them that they were ripe for financial distress. Some degree of confidence has been broken over the past six weeks. I wouldn’t say it has been reestablished, but I think that is probably one of the things in the post Sarbanes-Oxley era that are giving the decisionmakers at these financial institutions a little less interest in diving back into these markets—they learned that maybe what they had at their disposal or what they thought they knew wasn’t as certain as they had hoped. Many of these financial institutions during the past several weeks still thought that another leg down was possible—that strong financial institutions were continuing to ensure, and would continue to ensure even today, against four-sigma events—and that the best way for them to lose their jobs in this environment was to be short of liquidity. They are also very focused on what is happening among their peers. They are very focused on their relative strength, and they certainly want to be the survivors if the situation gets dramatically worse. All of these are in some ways ex post rationalizations for why many of these institutions didn’t serve in the shock-absorber role that we would have expected them to take quickly after market distresses had begun. I think they are getting used to the new environment. They have long since forgotten the robust times and the robust profits of the past five years, and they are looking at their capital ratios and getting some comfort from what their people are telling them. But when we look at these financial institutions, we are probably more prudent to judge them by their actions rather than what these capital ratios would suggest. Their actions are still not ebullient. Their actions are still not overly opportunistic. I said before that liquidity is confidence. Well, in times like this, I might be wrong. Liquidity is oxygen. They can’t live without it, and no price can compensate them during this liquidity replenishment period for a lack of oxygen. I think O2 levels might now finally be returning, so that they can enter phase 2 of this process, when they are able and willing to part with their cash. Phase 2, thus, is about finding new market-clearing valuations, being able to discriminate among differentiated assets, and being able to put opportunistic capital to work. Admittedly, I’d say this valuation phase is less advanced than the liquidity phase, but the process of price discovery is slowly but surely working its way through these asset classes. High-yield bonds are one example. Chrysler priced high-yield bonds at 95. A couple of days later they were trading at 99. Other sorts of leveraged loans and high-yield financing have indicative prices in the mid-90s, but there are very big pipelines, as we have discussed before, that could take a while to clear. My best guess is that we won’t see those markets clearing until after the commercial banks announce their third-quarter results. So in mid-October, we might see a new estimate of that, but I will admit it’s very hard to say. The price-discovery process around subprime mortgages is less advanced, but even there we are seeing trading desks asking the executives on the top floor for balance sheet capital because they see great prices for which they just need the balance sheet. That those discussions have begun and are somewhat more advanced than when we last talked is an encouraging sign, but the process of adjustment to the new market realities will take time. Bill Dudley spoke in great detail about other important developments—discrimination among asset-backed commercial paper programs being made depending on sponsor and collateral, financial institutions and the counterparty risk they represent being differentiated, and commercial banks more so today than even some weeks ago willing to invest in jumbo prime mortgages in the expectation that the securitization markets will reopen. It strikes me that we are substantially advanced in the liquidity phase and only somewhat advanced in valuation. That would take us to the third phase. The third phase is about the cost of capital. We’ll talk about it more in the next round, and optimally I would say that the liquidity replenishment and valuation necessary would be far more advanced before monetary policy actions would have to be put into place. But I think we bought ourselves some time, and this strikes me as the right moment for us to take monetary policy actions. The good news is that we have seen some tentative progress in those first two phases, and we’ll talk more about our actions to come. Let me just highlight a few more issues. What are the key challenges? What are the things to which we might want to look to see if the situation continues to improve modestly or reverses itself? I would look at a few things. First, as you look at some of these SIV structures and conduits, particularly outside the mortgage assets, to this point they are largely suffering from a liquidity crisis rather than a credit crisis. That could change if the real economy falters, and that is an additional reason for us to take monetary action today. Second, many still believe that it’s not safe to come out and play, and they are continuing to hunker down. I would have thought, right when this started brewing in the middle of August, that by now folks would have been more comfortable, but the median person is still more scared than I would have expected. Third, leverage is harder to come by. Even on investments for which the credit work seems pretty easy, like high yield, it is hard to get leverage alongside these equity placements, making folks less interested to jump back in a big way because the returns aren’t there. Another indicator I’d look to is the medium-term note market, which we haven’t discussed a great deal but is really a sibling of some of these other commercial paper markets. They don’t appear to be too distressed at this time, but as mentioned earlier, I would also look at the mortgage-backed securities around commercial real estate. The lack of term funding, which we’ll discuss when we discuss the auction term facility, has put financial market improvements at some risk. Even though we have been seeing real improvements in recent trading days, the prospect that these institutions are rolling over their funding and looking for funding every day strikes me as significantly increasing the tail risk and suggests that we need to take action. Finally, on the real economy, having spoken to a range of credit card companies yesterday to try to get their sense of three things, I can give I think generally positive reports. First, as a measure of retail sales, the view of institutions that cater to the high end, the middle end, and the low end is that retail sales in August and through the first two weeks of September were fine, not great. But when I asked them the question “If you weren’t aware of what was happening in the financial markets and you were just to review these data, does it look as though something happened? Does it look as though there was some exogenous shock?” to a person the answer was, “No, it looks as though things are coming along okay.” I think that’s reasonably encouraging. Second, I asked them about the credit quality of consumer behavior, whether delinquencies for individual credit card behavior at the low, medium, or high end had changed, and the answer was that they really hadn’t changed much. They can look and find yellow or red flags, but they said generally that consumer credit quality also looks fine. I’d say the biggest caution from three or four of these credit card companies came on the corporate side. Corporations wanting to be more protective, being more risk averse during this period, seemed to have cut back on allowable expenses for things like airlines, hotels, conferences, and the like, so their corporate credit volume had slowed up somewhat—but, again, nothing overly dramatic. Last, I would just share the uncertainty and hesitation that has probably crept its way back into boardrooms generally as many of these companies outside the financial sector are trying to figure out what the crystal ball looks like for the real economy. That hesitation is not useful, and as I said at the outset, I think the best case is that we give up a couple of tenths of GDP. Thank you, Mr. Chairman." CHRG-111hhrg48674--215 Mr. Bernanke," Sir, as I have indicated, people sometimes argue that once interest rates get to zero that the central bank can't do anything else. Well, we have found some other ways to try to ease financial conditions, and I have talked about three general areas: One is lending to banks, financial institutions, increase their liquidity; the second is to buy securities, including mortgage-backed securities, which lowers mortgage rates and strengthens that market; and then the third is to use various tools to try to address specific credit markets like the commercial paper market and the asset-backed securities market. I think we are going to have to explore what the alternatives are and see which markets could use assistance and whether we have tools available between us, the Treasury, and other agencies to address those problems, so I really can't tell you now. But our most immediate plans, as discussed this morning, would be to expand the TALF to include other types of asset-backed securities like commercial, mortgage-backed securities. " FOMC20070628meeting--134 132,MR. WARSH.," Thank you, Mr. Chairman. Regarding overall economic growth, my own macroeconomic views are not inconsistent with the central tendency of the projections that were pulled together for this meeting. I think the staff and the participants around the table deserve significant credit for being stubborn about the moderate-growth hypothesis while markets have been on all sides of it. The markets appear ready to look through the second-quarter GDP growth number, which appears to be a bit above trend. I’d say that we have gotten some credit from the markets for being stubborn and stubbornly right on our economic forecast, but they certainly haven’t given us their proxy, and I would not expect them to do so. They happen to share our views for now is what I would say, and I wouldn’t expect that situation to remain over the forecast period. Again, neither should our intention be to somehow get these curves to match over the coming several quarters. On the inflation picture, though it has improved a bit—and I am trying not to disregard very good news—I must say that it strikes me as thoroughly unconvincing. To me, inflation, in our old statement language, remains the predominant risk. I am less certain that core will continue the recent trend. I do believe that headline inflation may be telling us something in terms of secular trends around energy and food that we can’t dismiss, and the warnings from some of the other signals that we would see as rough proxies for inflation are still very real. Regarding what the financial conditions are telling us about growth, it strikes me that, from all the data we have received between our last meeting and this, financial conditions might be as different as any other sets of data that we received. My view is that financial conditions are still supportive of growth, but somewhat less so. It is hard to determine at this point how much, but let me take a stab at doing just that. Since we last met, as Bill said at the outset, we witnessed ten-year Treasury yields increase on the order of between 30 and 50 basis points. I am not uncomfortable with that incremental tightening of policy in the financial markets, but we have to be careful of what we wish for. I think the explanation from our staff here in Washington and Bill and the staff in New York is right, which is that markets have not come to a rosier view of the future. All they have really done is to take out the downside risk that came out of the first quarter. As the data came in a bit above expectations, that insurance bet that they had—that we were wrong and would have to cut rates—really lost credibility. I think their central view of the economy now is not one that roars back but one that is quite consistent with the moderate growth story. The financial markets have indeed tightened policy somewhat. Even since the time that the Bluebook was produced last week, spreads have apparently widened in addition to the risk-free rate being somewhat higher. But this is all happening in very real time, and my report a week ago would have sounded quite a bit different from the one today. We have witnessed increased term premiums and greater volatility across many, if not all, financial markets. Both the MOVE index for Treasuries and the VIX for equities are high relative to the averages of the past year but are still fairly reasonable over a somewhat broader period—say, the last five years. Term premiums I would characterize as returning to more-normal levels—but, again, not out of line with history. We have seen in the Bluebook that credit default swap (CDS) spreads and other spreads had widened, but that yet hadn’t happened in the high-yield market, where apparently there was some narrowing of spreads. That has changed rather dramatically in the past four or five trading days. I’m sure Vince will share more information on this tomorrow. But the CDS spreads really occurred first; then there was a lag to high-yield spreads. In the past two weeks, investment-grade CDS spreads have widened about 7 basis points, high-yield CDS spreads have widened about 20; a relatively new index of loan CDS spreads has widened about 65 basis points; and most, if not all, structured products, even assets wholly unrelated to the housing markets, have been undergoing some spread widening. As I mentioned, high-yield spreads appear to be catching up to CDS spreads, and with the incredible flow of deals in the market, I would guess that the trend continues. We’re seeing higher financing costs and slightly tougher terms for LBOs; the latter is a remarkable new development. M&A prices, probably for the first time since I have been sitting at this table, appear in the markets to be coming off their levels. So when auctions for properties of publicly traded companies are occurring, the price between initial indications of interest and final bids for the first time may actually be coming down. Why is that? Interest coverage ratios cannot go much below where they have been in this cycle. It is 1.2 or 1.3 times, but again, as the risk-free rate has gone up, as spreads have widened, you can buy just a little less debt for that. As a result, equity players that do not want to compromise their equity returns can pay a little less for these properties. Whether this phenomenon is very short term, like the phenomena we heard about after the tumult in late February and we returned to in the heady days of the capital markets, I do not know. This may just be a temporary preference shift toward quality and toward higher volatility and a return to the “glory” days, but I tend to think not. It is a tough call, and I reserve the right to change my judgment. I think that the new supply that’s coming into the markets, most of which needs to get priced before the markets slow down in August, will test the markets’ resilience, will test prices, and will test terms. Up to this point we have seen very little reduction in liquidity, but we are seeing a few deals being pulled from the market. Pricing power appears to be coming back to investors, and negotiations around prices and terms seem significantly more balanced than they have been in a very long time. Some of the instruments that we have sort of giggled about around this table—the pay-in-kind notes with optional cash payment— seem to have lost some traction in the market in the past week. I do not know whether they will return, but I take this new discipline in the markets as an encouraging sign. So what is going to be the resulting effect on prices, terms, and conditions? That is something we will have to judge; but financial conditions, as I said at the outset, are perhaps somewhat more restrictive than they were, but they should still be quite supportive of growth. At the outset I talked about the risk on the inflation front. Let me build on a couple of remarks that Vice Chairman Geithner made about risks now in the financial markets. If the problems that we have seen around structured products that have come out of the Bear Stearns scenario are really about the subprime markets and subprime collateral and housing, there’s not much to worry about. But to the extent that the story is really about structured products—products that have not been significantly stress-tested—then there is a risk that the financial markets may react and overreact. That scenario will bring up reputational risk issues. Even financial intermediaries that are in the agency business are relearning the lesson that agency business is not free—that there are, in fact, dissynergies from being in the principal investment business and the agency business under one marketing name. We are learning a lot about what the markets believe about the transparency of prices, particularly in times of financial distress. Of course, in times of distress, the correlations among all these assets do not look as they do in models, and that is something that will play itself out. I think that Tim rightly referenced the role of gatekeepers in the credit agencies, who I suspect are going to have a fairly rude awakening over the next six to nine months. As I also said, regarding this financial innovation, which on net is of great benefit to us, we will really see some of the products tested. Along with the products, moreover, the market participants’ behavior will be tested, perhaps in this upcoming period, as never before. So the financial markets are a friend on this, but there is greater risk than there was when we last met. Thank you, Mr. Chairman." CHRG-110shrg50409--58 Chairman Dodd," Thank you very much. Senator Bunning. Senator Bunning. Thank you, Mr. Chairman. Since I did not give an opening statement, I want to give an opening statement in all deference to Chairman Bernanke. I know we have a lot of ground to cover today, but I want to say a few things on the topic of this hearing and the next. First, on monetary policy, I am deeply concerned about what the Fed has done in the last year and in the last decade: Chairman Greenspan's easy money in the late 1990s and then followed the tech bust, inflated the housing bubble, and created the mess we are in today. Chairman Bernanke's easy money in the last year has undermined the dollar and sent oil prices to a new high every day, and an almost doubling since the rate cuts started. Inflation is here and hurting us and the average American, and it was brought out very clearly by the Senator from Pennsylvania. Second, the Fed is asking for more power, but the Fed has proven they cannot be trusted with the power they have. They get it wrong, do not use it, or stretch it farther than it was ever supposed to go in the first place. As I said a moment ago, their monetary policy is the leading cause of the mess we are in. As regulators, it took until yesterday to use the power we gave them in 1994 to regulate all mortgage lenders. Then they stretched their authority by buying $29 billion worth of Bear Stearns assets so JPMorgan could buy Bear Stearns at a deep discount. Now the Fed wants to be a systemic risk regulator, but the Fed is a systemic risk. Giving the Fed more power is like giving a neighborhood kid who broke a window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that, and I will use every power in my arsenal as a Senator to stop any new powers going to the Fed. Instead, we should give them less to do so they can get it right, either by taking their monetary responsibility away or by requiring them to focus only on inflation. Third, and finally, since I expect we will try to get it right to question the next hearing, let me say a few words about the GSE bailout plan. When I picked up my newspaper yesterday, I thought I woke up in France. But, no, it turned out it was socialism here in the United States of America, and very well, going well. The Treasury Secretary is now asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed purchase of Bear Stearns assets was amateur socialism compared to this. And for this unprecedented intervention in our free markets, what assurance do we get that it will not happen again? Absolutely none. We are in the process of passing a strong regulator for the GSEs, and that is important. But it allows them to continue in the current form. If they really do fail, we should let them go back to what they were doing before? I doubt it. I close with this question, Mr. Chairman. Given what the Fed and Treasury did with Bear Stearns, and given what we are talking about here today, I have to wonder what the next Government intervention into the private enterprise will be. More importantly, where does it all stop? Thank you. " FOMC20071031meeting--190 188,MR. STERN.," Thank you, Mr. Chairman. As I commented yesterday, I think there’s a respectable chance that by the middle of next year or so the economy will be growing again at a reasonable rate, and because of the lags between our actions and their effects on the economy, there is not a lot we can do about what happens in the intervening period anyway. It seems to me that those kinds of considerations are at the heart of something like the case for alternative B. Leave well enough alone. There has been some progress in the financial markets, and that step—that is, taking no action today—would in my view be consistent with long-term achievement of the dual mandate. But I am an economist. So on the other hand, financial conditions are still unsettled, and it’s difficult to know the degree of restraint that changes in the cost and availability of credit relative to conditions back in June will have. It might well be prudent—this is the case for alternative A—to take additional steps today to err on the side perhaps of doing too much since it seems to me that it is inevitable that a lot of uncertainty is associated with the economic outlook. Weighing those two cases, I come down in favor of alternative A but with misgivings, and let me share those misgivings. I think that there is some chance that financial conditions will remain unsettled for several more months at a minimum, and so in some sense that part of the environment may not change very much in the next few months. You pointed out yesterday, Mr. Chairman, that an important ingredient in the Greenbook forecast is a cessation of the drag from housing roughly around the middle of next year. Let’s suppose that, in fact, turns out to be precisely correct. That’s all well and good, but we won’t recognize that it has actually happened with any degree of confidence, given the flow of data, probably before August or September at the earliest even if the anecdotes get a little more positive. So I can see a situation in which the circumstances we confront over the next series of meetings don’t look very different from the circumstances we’re confronting today. I think we have to be very careful of not letting good intentions on a decision-by-decision basis get into what turns out to be a policy error as a consequence of an accumulation of those kinds of decisions. It’s the time-inconsistency problem obviously, and that gives me some pause even though I come out at the moment in favor of alternative A. As far as directive language, for a variety of reasons that others have expressed, I am uncomfortable about characterizing the balance of risks the way they are characterized in alternative A. I think that a way we might consider going, although it’s not the most elegant solution, is perhaps just to drop that first sentence under alternative A. We succeeded at the last meeting in making it clear that we were data dependent, and you had significant swings in probabilities of funds rate reductions over the intermeeting period. I think this would leave us in that circumstance. As President Pianalto pointed out, we have the minutes coming out, and we may well have the communications package, including the narrative, coming out with it. Obviously there’s a three- week lag, but it seems to me that that would be an effective way of communicating what we want to communicate and perhaps of putting the attention on that communications package, which I think would turn out to be valuable." FOMC20070321meeting--190 188,MR. STERN.," No, I don’t want to speak strongly in favor of retaining the reference to financial conditions. But I do think, along the lines that Governor Kohn expressed, that we need to provide some basis for our expecting moderate growth to continue. Otherwise that sentence does come across as an act of faith and doesn’t seem to me to be particularly compelling. I don’t see that mentioning financial conditions does us any damage, and it’s actually valuable in providing some rational for that judgment—and that is the judgment." CHRG-111hhrg51592--21 Mr. Sherman," Thank you. Most entities will eventually work in their own interest. Patriotic speeches and appeals to patriotism only go so far. This is an industry that gave AAA to Alt-A, and is as responsible for where we are now as anyone else playing on Wall Street. Two things create this self-interest. The industry is picked by the issuer, and believes it cannot be sued by the investor. One of those two needs to change. Now, the public accounting forms are picked by the issuer, but they're subject to lawsuits. The auditing firm that audited WorldCom doesn't exist anymore. And in the old days, they were general partnerships, so 100 percent of all the partners' personal equity would be gone. That provided even more incentive to provide for a good audit. If we're not going to force the firms to renounce any First Amendment arguments as a condition for doing business on Wall Street, then we need to end the system where they're picked by the issuer. Otherwise, there will be a race to satisfy the issuer by providing the highest ratings to the issuer and we'll get AAA on Alt-A. It won't be mortgages next time, it'll be some other kind of bond. And we'll be back here in another economic crisis. We don't allow the pitchers to pick the umpires. If we did, the strike zone would go from the ground to well above the head. We cannot allow the issuers to pick the bond-rating agencies or the credit rating agencies unless we're going to then bring in trial lawyers with instant replay cameras. That would assure that the umpires wouldn't cater to the pitchers, if they were subject to lawsuits and instant replay. But one of those two things needs to change, or the fear of God will prevent us from being in this situation with mortgages for a few years, but we'll be back here in another semi-depression with some other kind of credit instrument. I yield back. " CHRG-110shrg50369--87 Mr. Bernanke," Yes, Senator. First of all, as you know, we cut rates by about 100 basis points during the fall, reacting to the drag on the economy arising from the housing markets and from the credit market situation. Around the turn of the year and early in January, the data took a significant turn for the worse, and it seemed clear that the economy was slowing, and slowing more than anticipated, and that the credit market condition situation was continuing. On January 9, I called a meeting of the Federal Open Market Committee by video conference to discuss the situation. It was agreed by the committee that some substantial additional cuts in the Federal funds rate were likely to be necessary. The thought at the time of that meeting was that it might be worth waiting until the regular meeting at the end of the month where we could have a fuller discussion and see the revised forecast and so on, taking into account the possibility that we could also move intermeeting, if necessary. On January 10, I gave a speech where I informed the public that I thought that substantive additional action might well be necessary, thereby signaling that the conditions had changed and that further rate cuts were likely to happen. In the days that followed that speech, the tone of the data deteriorated considerably further, which made me think that the outlook was, in fact, much weaker and the risks were greater. That was showing up both in the data and in the financial markets. We were seeing sharp declines in equity prices. We were seeing widening of spreads. And we were also seeing, again, adverse data. On January 21, I became concerned that the continued deterioration of financial markets was signaling a loss of confidence in the economy, and I felt the Fed, instead of waiting until the meeting, really needed to get ahead of that and take action. So I called an FOMC conference call, and we agreed at that point to cut the Federal funds rate target by 75 basis points. There was an understanding at that meeting that further additional action was very likely to be needed, but we felt that we could wait another 10 days until the regular meeting to determine exactly how much additional action. At the meeting at the end of January, we had a full review, discussion, forecast round and so on and determined that an additional 50 points was justified. Looking back, as the data have evolved, I think that the 125 basis points was appropriate for the change in the tone of the economy, and I think it was the right thing to do. Senator Bunning. Are the days of constant and gradual Fed rate changes over? In other words, are large and intermeeting rate changes going to become a regular part of the Fed toolbox now? " CHRG-110hhrg45625--78 Mr. Bernanke," I would just make the point, as the Secretary did, that historically these situations have dealt with institutions that have already failed or primarily close to failing. In that case you take the assets off the balance sheet, or you just put capital in them, and then you take all the ownership and restore them to functioning. In this case, we have two differences. One is that the banking system for the most part is still an ongoing concern. It is not extending credit to the extent we would like, but it is not failing. If there are failing institutions, we can address those individually. But more broadly, the problem is that with the complexity of these securities and the difficulty of valuation, nobody knows what the banks are worth and therefore, it is very difficult for private capital to come in to create more balance sheet capacity so banks can make loans. So it is a rather different situation from past episodes. That being said there is flexibility in this, and I think it is the intention of the Secretary, and certainly I would advise him--under the oversight of the oversight committee or whatever is set up to watch over this process--to be flexible and respond to conditions as they change. If this process is not working effectively, there are other ways to use this money that will again purchase assets or purchase capital and support the banking system. " CHRG-110shrg50416--152 Chairman Dodd," Who fills the vacuum? Where would it be today without this right now? You just said it. I would like to repeat that. What would happen if this did not--what condition would we be in today in the absence of that? " FOMC20081029meeting--209 207,MR. EVANS.," Thank you, Mr. Chairman. In spite of the fact that I am going to validate what President Fisher said in terms of content, I am reminded of what candidate Ronald Reagan said in 1980 against George Bush. To paraphrase, ""I paid for the plane ticket down here. I'm going to tell you what I learned."" [Laughter] Pessimism is running deep, and no one I spoke with this round was immune to the current economic and financial turmoil. Even contacts who have sworn for months that their prudent financial management had insulated them from funding difficulties now report being stressed. The speed of the turnaround in sentiment has been breathtaking. Some of these new reports about changes in financing conditions came from large manufacturing firms that had been doing well this cycle. For example, John Deere noted that its financing subsidiary was having difficulty rolling medium-term notes that fund their customer leases. This seems symptomatic of financial stress because the subsidiary has a large capital cushion with high-value collateral backing the leases. Caterpillar did have better luck getting such funding but only because it went to the market during a very brief window when lenders were actively seeking customers with high credit quality. I also heard numerous reports of businesses having difficulty renewing longstanding lending arrangements with their banks; and for those who were able to get new loans, the terms were typically viewed as unattractive--at least they felt so. Several Chicago directors indicated that businesses were successfully tapping existing loan commitments and revolving credit, much along the lines that President Yellen just mentioned. However, this was not greeted enthusiastically by their bankers. In fact, I heard a very interesting story about a major New York bank CEO who spent some time in Chicago a couple of years ago. He was calling a large customer to assure him that their credit lines were good and that they didn't need to be taken down preemptively. The customer, who is our chairman, listened politely and then tapped the line anyway. [Laughter] No wonder banks are worried about their liquidity position. With regard to nonfinancial developments, reports on both current and expected real activity have turned uniformly more negative. An abrupt change occurred in September. People are spooked--sorry--[laughter] and it is showing through to spending. Retail sales are weak. I have grown accustomed to the inherent pessimism of one of my retail contacts. He has often said that business has never been weaker in 40 years, but this time he said never in 46 years. I also heard many reports about how the slowing in demand is worldwide. In my District, the sharp slowdown is evident in the Chicago purchasing managers' index. In October, it plunged nearly 20 points, to 37.8, the lowest level since the last recession in May 2001. This index will be publicly released on Friday. Businesses appear to be responding to the drop in demand by doing anything and everything they can to cut back spending. Labor demand is way off. My Manpower contact indicated that even companies that are doing well had turned cautious about hiring and are trying to squeeze out more productivity. He thought that the drop in sentiment could have some extra impact, given that it was occurring during the annual planning cycle for corporations. The idea was that a lot of harder-to-sell structural adjustments were being implemented anyway and that CEOs wanted to get these moves done quickly and have them behind them by early 2009. This is consistent with a range of reports we have heard that new capital spending is dead in the water or that planned expansions are being canceled. On a positive note, I think we are seeing the benefits of the structural improvement and inventory management that has occurred over the last 25 years. My contacts are reporting some increases in inventories, but they think that so far they have kept stocks under relatively good control. With prompt production cuts, we may not get the additional downside of a big inventory swing later in the cycle, perhaps when it is more painful. Turning to the national outlook, our forecast envisions a full-blown recession, roughly on the scale of the Greenbook. But like everyone else, I have a great deal of uncertainty about this projection. Things could turn out a lot worse. In contemplating the transmission from recent financial events to the real economy, there seem to be at least two channels to note. First, there is the dramatically reduced availability and higher cost of credit. Second, a recessionary psychology has emerged strongly in households and businesses. With regard to the psychology, I haven't spoken with anyone this round who thought there was a good reason to undertake any kind of discretionary expenditure. Clearly, the self-reinforcing dynamics implied by these and other reports could generate a deeper downturn than I have written down in my forecast. That's a big risk. With regard to the credit channel, the hit to the nonfinancial sector has intensified a good bit. We clearly are sailing in uncharted waters when it comes to quantifying these effects. The factors identified in the Greenbook highlight the unprecedented nature of the financial impulses to the economy. Looking ahead, I expect that the improvement in financial conditions will be somewhat faster than in the Greenbook. That is my cautious optimism. Still, in our forecast, financial headwinds weigh substantially on growth throughout 2009 and continue, to a degree, into 2010. Accordingly, substantial resource gaps remain open throughout the projection period. Also, I expect inflation expectations to decline in this depressed environment. With greater slack, lower inflation expectations, the reduction in energy and other commodity prices, and the higher value of the dollar, we are projecting core inflation to move under 2 percent by 2010. And I won't be shocked if the Greenbook projection for this to happen in 2009 actually happens. So, on balance, I think that inflationary risks are low but the downside risks to the economy are very high. Much as President Fisher indicated, it is much in line with the reports so far. Thank you, Mr. Chairman. " CHRG-111shrg54789--79 Mr. Barr," Thank you, Senator. Our judgment is that the new agency will have the ability to set high standard across the financial services marketplace, including for mortgages, that we will continue to see innovation in the mortgage sector, but that if firms want to offer products that are difficult for consumers to understand, there will be a higher burden on them to explain those products and services. And I think that we have seen the consequences of a system in which there is inadequate supervision of those kinds of practices. So I do think we are going to see a rebalancing, if you will, where it is a much lighter regulatory burden even than we have today with respect to straightforward products. So you can do things like combine the Truth in Lending Form and the Real Estate Settlement Practices Form into one simple Mortgage Disclosure Form everybody can use. That is easy under the new approach, very hard under the current approach. It is a way of reducing regulatory burden for banks, improving disclosure for consumers. We can see a lot of that happening in this space with the new agency. Senator Johnson. My time is up. " FOMC20070807meeting--57 55,MS. YELLEN.," Thank you, Mr. Chairman. Data on inflation during the intermeeting period have continued to be encouraging, but the prospects for economic activity have become dicier. The results for GDP in the second quarter as a whole actually took on a positive tone, with final sales mainly accounting for the healthy growth rate. But the quarter ended on a weak note, with disappointing data for housing consumption and for orders of core capital goods. Of course, the big developments since our last meeting were in financial markets. I read them as pointing to weaker growth going forward and greater downside risk. The market for mortgage- backed securities is now highly illiquid, and there are indications that credit problems are spilling beyond the subprime sector. It thus seems likely that lending standards will tighten for a broader class of borrowers in the mortgage market. The drop in equity prices and rising rates on most risky corporate debt are further negatives for growth. There are some offsets to these negative factors, including the decline in the dollar and, most important, the steep reduction we have seen in risk-free rates. On balance, however, I expect these offsets to be only partial, providing a cushion against future weakness, because I interpret the decline in Treasury rates during the intermeeting period primarily as a reflection of weaker growth expectations and a correspondingly lower path for the expected future fed funds rate and not a consequence of the fall of the term premium. The jump in oil prices since our last meeting is a further factor weighing on aggregate demand. As a result of these considerations, I have lowered my growth forecast for the second half of this year ½ percentage point, to just over 2 percent. This rate is moderately below my estimate of potential growth, which I now put at about 2½ percent. Going beyond this year, the outlook depends on one’s assumption concerning appropriate monetary policy. I consider it appropriate for policy to aim at holding growth just slightly below potential to produce enough slack in labor and credit markets to help bring about a further gradual reduction in inflation toward a level consistent with price stability. Barring a more serious and prolonged tightening of credit market conditions or a general liquidity squeeze, I would keep the fed funds rate modestly above its equilibrium level to accomplish this goal. However, I now see the fed funds rate as well above the neutral level. So I think it likely that the fed funds rate will need to fall appreciably over the next few years. My assessment of the neutral federal funds rate declined during the intermeeting period for two main reasons—first, because of the tightening in financial conditions associated with the reassessment of risk now taking place and, second, because of the NIPA revisions, which suggest slower structural productivity growth and, in all likelihood, correspondingly slower growth in aggregate demand. I thus think that a larger decline in the fed funds rate will be needed over time than in the Greenbook baseline to achieve a soft landing. A key development during the intermeeting period was the downward revision of real GDP growth over the 2004-06 period. This adjustment reinforces the work of productivity experts at the Board and elsewhere who had previously found evidence of a slowdown in underlying productivity growth. The revision in actual productivity was big enough to lead us to lower our estimate of growth in both structural productivity and potential output, although our estimates remain above those in the Greenbook. In addition to tighter financial conditions, lower structural productivity growth was the reason that we lowered our forecast for real GDP growth to 2¼ percent in 2008. As a result, the unemployment rate edges up in our forecast, reaching nearly 5 percent by the end of next year. The modest amount of slack that this entails should help bring about the desired gradual reduction of inflation in the future. Readings on core PCE prices have been quite tame for some time now, rising only 0.1 percent in each of the past four months. Although a portion of the recent deceleration in core prices likely reflects transitory influences, the underlying trend in core inflation still appears favorable. We anticipate that the core PCE price index will rise 2 percent this year and that core inflation will gradually ebb to around 1.8 percent over the forecast period. This forecast is predicated on continued well-anchored inflation expectations and the eventual appearance of a small amount of labor market slack, as I just mentioned. For some time now, I’ve thought an argument could be made that the NAIRU was a bit lower than assumed in the Greenbook, and the new evidence that structural productivity growth has been lower than we thought for more than three years reinforces this view. It means that the relatively good inflation performance over this period occurred despite the upward pressure that must have been operating because of the deceleration in structural productivity. In any event, I also expect to see modest downward pressure on inflation in the next couple of years from the ebbing of the upward effects of special factors, including the decline in structural productivity, energy and commodity prices, and owners’ equivalent rent. In terms of risk to the outlook for growth, the housing sector obviously remains a serious concern. We seem to be repeatedly surprised with the depth and duration of the deterioration in these markets; and the financial fallout from developments in the subprime markets, which I now perceive to be spreading beyond that sector, is a source of appreciable angst. Of course, financial conditions have deteriorated in markets well beyond those connected with subprime instruments or even residential real estate more generally. It appears that participants are questioning structured credit products in general, the risk assessments of the rating agencies, and the extent of due diligence by originators who package and sell loans but no longer hold a very sizable fraction of these originations on their own balance sheets. The Greenbook has long highlighted, and we have long worried about, the possibility and potential consequences of a broader shift in risk perceptions. With risk premiums having been so low by historical standards, it would hardly be surprising to see them rise, making financial conditions tighter for any given stance of monetary policy. While it remains possible that financial markets will stabilize or even reverse course in the days and weeks ahead, the possibility that the financial markets are now shifting to a historically more typical pattern of risk pricing is very much on my radar screen. Should this pattern persist and possibly intensify, it will have very important implications for policy." FOMC20070321meeting--192 190,MR. HOENIG.," Mr. Chairman, I don’t have any problem. I agree with Cathy on the length. At the same time, I don’t think focusing on financial conditions is a particular problem because what you’ve said about having that in there can be said about anything else that you put in. What happens next time if income is lower and so forth? So I don’t think that “financial conditions” in and of itself matters one way or the other. I also agree with Governor Kohn that we do need to have a rationale. We can’t just take it on faith. We went down this road some time ago, and this is what we have now; so I think we do owe people some explanation, Cathy." FOMC20060920meeting--159 157,MR. POOLE.," Am I the only taker to be number one? [Laughter] Thank you, Mr. Chairman. I want to start with two observations. First, the distribution of the market’s outlook for the federal funds rate six months ahead—and the briefing paper that appeared in my hotel room last night has that shown on exhibit 1—is pretty symmetrical, although it actually has a bit more probability weight on declines in the rate than increases. But roughly speaking, it accords with my own view—a one-third chance that we will stay where we are, a one-third chance that it will be appropriate to ease, and a one-third chance that we will want to increase the rate. I come out with a very symmetrical view myself. I think of the views around the table—some people are probably there, some people are probably skewed on one side and some on the other side, but I come out very much in the middle. My second observation continues a point that Tim Geithner made a few minutes ago. I had several conversations at Jackson Hole with Wall Street economists and journalists, and they said, quite frankly, that they really do not believe that our effective inflation target is 1 to 2 percent. They believe we have morphed into 1½ to 2½ percent, and no one thought that we were really going to do anything over time to bring it down to 1 to 2. I think that is very unfortunate because so many of us have talked about 1 to 2. Also, it seems to me that in the future it would be easy for people to say, “Well, it is going to be inconvenient. Let’s just sort of settle at 2 to 3.” They have already said that they would be at 1½ to 2½ effectively by the behavior of the Committee. Now, if we get data in the coming months that are unfortunate on the inflation side and lead us to increase our inflation forecast in the absence of any further policy action, I would certainly be on the side saying that we ought to act. We should firm policy so that we do not allow the forecast inflation to rise from where it is now. One reason that I do not want the explicit reference to housing to be in the statement is that I would take that position even if housing were continuing to struggle, because I think it is extremely important that we not allow inflation to ratchet up. If housing is a casualty of that policy, we had better accept that situation. I would not like to see a mixed market signal because I would not want the market to believe that continuing weakness in housing would deflect us from acting as necessary to keep inflation from rising further. I think the explicit reference to housing in the statement conditions the market to think about our policy going forward in the wrong way. At the same time, there is a clear possibility that we could see data in coming months that would be weaker than we now anticipate in the Greenbook forecast. What I know about forecasting error says that you have to think that coming in weaker on the real economy is a real, live possibility. I hope that we do not get unfortunate news on inflation and a downside on the real economy together, but I do not rule out that possibility. I think it is unlikely, if we receive substantially weak data on the real economy, that we would be raising rates into a recession. But quite frankly, I would like for us to condition the market to accept this symmetrical view of the risks that we face going forward and for us not to have language in our statement that tilts us toward tightening. My own sense is that an asymmetric tilt toward tightening would not serve us well should we get downside surprises in the real economy. Indeed, we should be quite happy to see longer-term rates weaken in the event of weak data on the real economy. To have the market respond that way helps to serve as a built-in stabilizer for economic activity. It would tend to support housing and other interest-sensitive sectors, and we should encourage rather than discourage that response in the market. Let’s see. What else do I want to say here? I would observe that the Greenbook forecast of a prolonged period of an inverted yield curve has no historical precedent. Usually the yield curve is inverted in the process of going from here to there, and you do not just sort of settle there. So I think that this situation is likely to be resolved either in the direction of higher long-term rates, as news on the real economy or inflation comes through in that direction or in the direction of lower short-term rates, for reasons I was just outlining; and I don’t know which direction it will be. My view of the current stance of policy is that it is moderately restrictive. Money growth, whether measured by MZM (Money Zero Maturity) or by M2, has been modest, and in fact, real balances have been flat to declining for a year or more, which would be a rather traditional sign that our policy is restrictive. Thank you." CHRG-111shrg52619--195 RESPONSE TO WRITTEN QUESTIONS OF SENATOR HUTCHISON FROM MICHAEL E. FRYZELQ.1. Will each of you commit to do everything within your power to prevent performing loans from being called by lenders? Please outline the actions you plan to take.A.1. NCUA has strongly encouraged federally insured credit unions to work with borrowers under financial stress. While credit unions must be prudent in their approach, there are avenues they need to explore in working through these situations that can result in positive outcomes for both parties. In April of 2007, NCUA issued Letter to Credit Unions 07-CU-06 titled ``Working with Residential Mortgage Borrowers,'' which included an FFIEC initiative to encourage institutions to consider all loan workout arrangements. NCUA subsequently issued Letter to Credit Unions 08-CU-05 in March of 2008 supporting the Hope NOW alliance, which focuses on modifying qualified loans. More recently, NCUA Letter to Credit Unions 09-CU-04, issued in March 2009, encourages credit union participation in the Making Home Affordable loan modification program. NCUA is currently in the process of developing a Letter to Credit Unions that will further address loan modifications. NCUA has been, and will remain, supportive of all prudent efforts to avoid calling loans and taking foreclosure actions. While NCUA remains supportive of workout arrangements in general, the data available does not suggest performing loans are being called at a significant level within the credit union industry. What is more likely to occur is the curtailing of existing lines of credit for both residential and construction and development lending. It is conceivable that underlying collateral values supporting such loans have deteriorated and no longer support lines of credit outstanding or unused commitments. In those instances, a business decision must be made regarding whether to curtail the line of credit. There likely will be credit union board established credit risk parameters that need to be considered as well as regulatory considerations, especially as it relates to construction and development lending. Credit union business lending is restricted by statute to the lesser of 1.75 times the credit union's net worth or 12.25 percent of assets (some exceptions apply). There are further statutory thresholds on the level of construction and development lending, borrower equity requirements for such lending, limits on unsecured business lending, and maximum loan to value limitations (generally 80 percent without insurance or up to 95 percent with insurance). While business lending continues to grow within credit unions, the level of such lending as of December 31, 2008, is 3.71 percent of total credit union assets and 5.32 percent of total credit union loans. Only 6.15 percent of outstanding credit union business loans, or $1.95 billion, are for construction and development, which is a very small piece of the overall construction and development loan market. Credit union loan portfolios grew at a rate of over 7 percent in 2008. The level of total unfunded loan commitments continues to grow, which suggests there is not a pervasive calling of lines of credit. Credit unions need to continue to act independently in regard to credit decisions. Each loan will involve unique circumstances including varying levels of risk. Some markets have been much more severely impacted by the change in market conditions, creating specific risk considerations for affected loans. Additionally, there are significant differences between loans to the average residential home owner who is current on their loan even though their loan to value ratio is now 110 percent, versus the developer who has a line of credit to fund his commercial use or residential construction project. Continued funding for the developer may be justified or may be imprudent. Continued funding may place the institution at additional risk or beyond established risk thresholds, depending on the circumstances. The agency continues to support the thoughtful evaluation by credit union management of each performing loan rather than a blanket approach to curtailing the calling of performing loans. ------ FinancialCrisisInquiry--360 VICE CHAIRMAN THOMAS: Thank you, Mr. Chairman. First of all, I want to thank all you. We have a very difficult job, and when you rely on secondary and tertiary sources, it makes it very, very difficult. And your willingness, one, to come in front of us and begin to answer the questions that we’re asking. I might just tell you, Mr. Chairman, based upon my request, we’ve already—over the Web—and I January 13, 2010 have some directed specifically to some of you. I won’t ask them now, but we’ll get it back in writing and we’ll communicate. We’ve got California, Tennessee, Connecticut, Missouri, and more coming in. This is going to be very useful to us. We want to assure you, as we have the administration, that any information provided to us will be handled in the appropriate legal and protective ways, especially sensitive with the private sector on Trade Secrets Act and other information. It’s just that, without your help in follow-up questions that we will ask to get some detailed understanding, that we can provide not just the rough picture of what happened, but a more nuanced, understood, in- depth picture of what happened because, frankly, an argument that I made a lot and then quit making when I was in Congress is that it’s basically you just don’t understand what we’re doing and the context we’re doing it. And I’m sure you’ve heard a lot of that. Our job, hopefully, is to provide as mild and easy a form of education as possible. Just how complicated this world is today and what makes it go round? Your help in that regard, as I said, is invaluable. We’ll ask you questions. We would hope we get a timely response. As we get nearer our time to exist it will be a bit pushier in terms of getting your response. But once again, Mr. Chairman, I want to thank the panel, one for their willingness to come. Two, their openness in response, and three, the answers you’ll be giving us over the course of the next eight months. Thank you very much. FOMC20080318meeting--55 53,MR. STERN.," Thank you, Mr. Chairman. Well, the baseline forecast in the Greenbook looked to me a lot like the 2001 recession experience--very brief and very mild. If things turn out that way, we will have been very fortunate, frankly. The forecast I submitted at the last meeting was lower than most around the table, and now my bottom line is that I think the recession that, if we are not in, we are confronting is more likely to resemble that of 1990-91, which, while brief, wasn't that mild. There were a couple of quarters, as I recall, where the economy contracted by at least 3 percent in real terms. I am not sure that this recession is likely to be as brief as the previous two either. I have tried to use the 1990-91 experience and its aftermath as sort of a guide to thinking about where we are today and how things might unfold and evolve because there are some significant similarities as well as some significant differences between the periods. But it is also a way for me to start to organize things and think about this. So let me just describe a few of what I think are relevant features from that experience and how today's circumstances are either similar or different. If you compare our circumstances today with what we were confronting back in 1991, on the positive side inflation and inflation expectations are both lower today. The unemployment rate is lower than it was going into that recession. Nominal and real interest rates appear to be lower today than they were back then. I think that nonfinancial business balance sheets are in better shape today on average than they were going into the 1990-91 experience, and depository institutions overall are in better shape today than they were back then, although of course they are having some very high profile problems. Of course, that was the period when we saw more or less the virtual demise of the thrift industry and problems of major banks. There was also a significant correction in housing activity, which commenced in 1987 and ran through into 1990. It wasn't as sharp as the one we are experiencing, but it was significant nevertheless. There was also a credit crunch back then, and that was given a lot of responsibility not only for the recession but for its aftermath--that is, the relatively sluggish recovery that occurred once the recession ended--because it was alleged that financial institutions, nonfinancial businesses, and households were all trying to strengthen their balance sheets simultaneously, and so there was a good deal of caution throughout the financial sector. So there are a number of similarities as well as a number of differences. When I think about today's circumstances, a couple of things come to mind. One is, as President Yellen summarized, that the breadth of negative news about the economy is striking to me. On top of that, I think today's financial problems are, without question, more severe and more intense than they were back then. They have engulfed many financial markets, as we are well aware. While there were declines in housing prices and housing values in some markets back then, the decline we are experiencing today is both more widespread and is likely, before it is done, to be a good deal deeper. So I think that at least a reasonable parallel is the kind of thing we experienced back in 1990-91. Now, on the inflation side, let me start with policy. We weren't targeting the federal funds rate back then. We were still wedded to the monetary aggregates, more or less. But the funds rate, nevertheless, provides some useful information. The funds rate, in early 1989, was around 9� percent. It got to 3 percent by September 1992, where it stayed until early 1994. I cite that because inflation, whether you look at core or at headline, actually diminished through that period. So while some people have been worried, and perhaps justifiably, that this is going to shape up like the late 1960s or much of the 1970s as far as inflation is concerned, all I would say about that is it is not a foregone conclusion if you look at history. I don't know that it is easy to distinguish how this is likely to play out, but that was a very significant series of policy moves undertaken back then, and inflation, nevertheless, diminished. The only other comment I would add to this--and it is not going to lift the gloom right away, certainly--is that these financial problems are going to persist. Even if they bottom out and conditions start to improve, I would expect that they will exert headwinds on the shape of the recovery. My view is that 2009 is not likely to be as healthy as the Greenbook envisions, largely as a consequence of the hangover of financial problems. Thank you. " CHRG-111hhrg48868--210 Mr. Clark," The government's approach; we don't have a view on whether it was appropriate or not, only that it has to some degree stabilized the condition of the company. " FOMC20070321meeting--178 176,MR. REINHART.," I was going to say that mostly the references would be to the stance of policy, as opposed to financial conditions." FOMC20071211meeting--82 80,MS. YELLEN.," Thank you, Mr. Chairman. At the time of our last meeting, I held out hope that the financial turmoil would gradually ebb and the economy might escape without serious damage. Subsequent developments have severely shaken that belief. The bad news since our last meeting has grown steadier and louder, as strains in financial markets have resurfaced and intensified and as the economy has shown clear signs of faltering. In addition, the downside threats to growth that then seemed to be tail events now appear to be much closer to the center of the distribution. I found little to console me in the Greenbook. Like the Board staff, I have significantly marked down my growth forecast. The possibilities of a credit crunch developing and of the economy slipping into a recession seem all too real. Conditions in financial markets have worsened. Rates on a wide array of loans and securities have increased significantly since our last meeting, including those on term commercial paper, term LIBOR, prime jumbo mortgages, and high-yield corporate bonds. CDS spreads from major financial institutions with significant mortgage exposure, including Freddie and Fannie, have risen appreciably. In addition, broad stock indexes are down nearly 5 percent. At the same time, measures of implied volatility in equity, bond, and foreign exchange markets have all moved up, reflecting the greater uncertainty about the economy’s direction. The most recent data on spending have been discouraging as well. Data on house sales, prices, and construction have been downbeat, and foreclosures on subprime loans have moved even higher. Even with efforts such as those facilitated by the Administration to freeze subprime rates, foreclosures look to rise sharply next year, which may dump a large number of houses on a market already swamped with supply. This will exacerbate the downward pressure on house prices and new home construction from already elevated home inventories. Indeed, the ten-city Case-Shiller home-price index has declined more than 5 percent over the past year through September, and futures contracts point to another sizable decline over the next twelve months. I am particularly concerned that we may now be seeing the first signs of spillovers from the housing and financial sectors to the broader economy. Although the job market has remained reasonably healthy so far, real consumer spending in September and October was dead in the water, and households are growing more pessimistic about future prospects. The December reading of consumer sentiment showed another decline, and the cumulative falloff in this measure is becoming alarming. Gains in disposable income have been weakened. With consumer sentiment in the doldrums, house prices on the skids, and energy prices on the rise, consumer spending looks to be quite subdued for some time. This view is echoed by the CEO of a national high-end clothing retailer on our board, who recently emphasized to us that the positive chain store sales data in November were in fact artificially boosted by the Thanksgiving calendar shift and that the underlying trend for his business has worsened notably. My modal forecast foresees the economy barely managing to avoid recession, with growth essentially zero this quarter and about 1 percent next quarter. I expect growth to remain below potential throughout next year, causing the unemployment rate to rise to about 5 percent, much like in the Greenbook. This forecast assumes a 50 basis point decline in the federal funds rate in the near future, placing the real funds rate near the center of the range of estimates of the neutral rate reported in the Bluebook. I should emphasize that I do not place a lot of confidence in this forecast, and, in particular, I fear that we are in danger of sliding into a credit crunch. Such an outcome is illustrated by the credit crunch alternative simulation in the Greenbook. Although I don’t foresee conditions in the banking sector getting as bleak as during the credit crunch of the early 1990s, the parallels to those events are striking. Back then, we saw a large number of bank failures in the contraction of the savings and loan sector. In the current situation, most banks are still in pretty good shape. Instead, it is the shadow banking sector— that is, the set of markets in which a variety of securitized assets are financed by the issuance of commercial paper—that is where the failures have occurred. This sector is all but shut for new business. But bank capital is also an issue. Until the securitization of nonconforming mortgage lending reemerges, financing will depend on the willingness and ability of banks, thrifts, and the GSEs to step in to fill the breach. To the extent they do, that will put further pressure on their capital, which is already under some pressure from write-downs on existing loans and holdings of assets. Banks are showing increasing concern that their capital ratios will become binding and are tightening credit terms and conditions. Several developments suggest to me that this situation could worsen. In addition to the problems plaguing the adjustable-rate subprime mortgages, delinquencies have recently started to move up more broadly—on credit card and auto loans, adjustable-rate prime mortgages, and fixed-rate subprime mortgages. My contacts at large District banks tell me that, because the economy continues to be reasonably healthy and people have jobs, things are still under control. But if house prices and the stock market fall further and the economy appears to be weakening, then they will further tighten the lending conditions and terms on consumer loans to avoid problems down the road, and these fears could be self-fulfilling. If banks only partially replace the collapsed shadow banks or, worse, if they cut back their lending in anticipation of a worsening economy, then the resulting credit crunch could push us into recession. This possibility is presumably increasingly reflected in CDS and low-grade corporate bond spreads. Thus, the risk of recession no longer seems remote, especially since the economy may well already have begun contracting in the current quarter. Indeed, the December Blue Chip consensus puts the odds of a recession at about 40 percent. This estimate is within the range of recession probabilities computed by my staff using models based on the yield curve and other variables. Turning to inflation, data on the core measure continues to be favorable. Wage growth remains moderate, and the recent downward revisions to hourly compensation have relieved some worries there. Inflation expectations remain contained. As I mentioned, I expect some labor market slack to develop, and this should offset any, in my view, modest inflationary pressures from past increases in energy and import prices and help keep core PCE price inflation below 2 percent. Continued increases in energy and import prices pose some upside risk to the inflation outlook, but there are also downside risks to inflation associated with a weakening economy and rising unemployment. To sum up, I believe that the most likely outcome is for the economy to slow significantly in the near term, flirting with recession, and I view the risk to that scenario as being weighted significantly to the downside. In contrast, I expect inflation to remain well contained, and I view those risks as fairly balanced." CHRG-111hhrg58044--44 Chairman Gutierrez," In your credit report, they are. If someone fails to pay a medical bill, it has a derogatory impact on my credit report, which is going to have a derogatory impact on my credit score. " CHRG-110hhrg45625--55 Mr. Bernanke," Thank you, Chairman Frank, Ranking Member Bachus, and members of the committee, I appreciate this opportunity to discuss recent developments in financial markets in the economy. As you know, the U.S. economy continues to confront substantial challenges, including a weakening labor market and elevated inflation. Notably, stresses in financial markets have been high and have recently intensified significantly. If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse. The downturn in the housing market has been a key factor underlying both the strained condition of financial markets and the slowdown of the broader economy. In the financial sphere, falling home prices and rising mortgage delinquencies have led to major losses at many financial institutions, losses only partially replaced by the raising of new capital. Investor concerns about financial institutions increased over the summer as mortgage related assets deteriorated further and economic activity weakened. Among the firms under the greatest pressure were Fannie Mae and Freddie Mac, Lehman Brothers, and more recently, American International Group (or AIG). As investors lost confidence in them, these companies saw their access to liquidity and capital markets increasingly impaired and their stock prices drop sharply. The Federal Reserve believes that whenever possible, such difficulty should be addressed through private sector arrangements, for example, by raising new equity capital, by negotiations leading to a merger or acquisition, or by an orderly wind-down. Government assistance should be given with the greatest of reluctance and only when the stability of the financial system and consequently the health of the broader economy is at risk. In the cases of Fannie Mae and Freddie Mac however, capital raises of sufficient size appeared infeasible and the size and government sponsored status of the two companies precluded a merger with or acquisition by another company. To avoid unacceptably large dislocations in the financial sector, the housing market, and the economy as a whole, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into conservatorship and the Treasury used its authority granted by the Congress in July to make available financial support to the two firms. The Federal Reserve, with which FHA consulted on the conservatorship decision, as specified in the July legislation, supported these steps as necessary and appropriate. We have seen benefits of this action in the form of lower mortgage rates, which should help the housing market. The Federal Reserve and the Treasury attempted to identify private sector approaches to avoid the imminent failures of AIG and Lehman Brothers, but none was forthcoming. In the case of AIG, the Federal Reserve, with the support of the Treasury, provided an emergency credit line to facilitate an orderly resolution. The Federal Reserve took this action because it judged that in light of the prevailing market conditions and the size and composition of AIG's obligations, a disorderly failure of AIG would have severely threatened global financial stability and consequently the performance of the U.S. economy. To mitigate concerns that this action would exacerbate moral hazard and encourage inappropriate risk taking in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant cost and constraints on the firms' owners, managers, and creditors. The chief executive officer has been replaced. The collateral for the loan is the company itself, together with its subsidiaries. Insurance policyholders and holders of AIG investment products are, however, fully protected. Interest will accrue on the outstanding balance of the loan at a rate of 3 month LIBOR plus 850 basis points, implying a current interest rate over 11 percent. In addition, the U.S. Government will receive equity participation rights corresponding to a 79.9 percent interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders, among other things. In the case of Lehman Brothers, a major investment bank, the Federal Reserve and the Treasury declined to commit public funds to support the institution. The failure of Lehman posed risks, but the troubles at Lehman had been well known for some time and investors clearly recognized as evidenced for example by the high cost of insuring Lehman's debt in the market for credit default swaps that the failure of the firm was a significant possibility. Thus, we judge that investors and counterparties had time to take precautionary measures. While perhaps manageable in itself, Lehman's default was combined with the unexpectedly rapid collapse of AIG, which together contributed to the development last week of extraordinarily turbulent conditions in global financial markets. These conditions caused equity prices to fall sharply, the cost of short-term credit, where available, to spike upward, and the liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets, a flight to quality, sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth. The Federal Reserve took a number of actions to increase liquidity and stabilize markets. Notably, to address dollar funding pressures worldwide, we announced the significant expansion of reciprocal currency arrangements with foreign central banks, including an approximate doubling of the existing swap lines with the European Central Bank and the Swiss National Bank and the authorization of new swap facilities with the Bank of Japan, the Bank of England, and the Bank of Canada. We will continue to work closely with colleagues at other central banks to address ongoing liquidity pressures. The Federal Reserve also announced initiatives to assist money market mutual funds facing heavy redemptions and to increase liquidity in short-term credit markets. Despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress. Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy. In this regard, the Federal Reserve supports the Treasury's proposal to buy illiquid assets from financial institutions. Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets while reducing investor uncertainty about the current value and prospects of financial institutions. More generally, removing these assets from institutions' balance sheets will help to restore confidence in our financial markets and enable banks and other institutions to raise capital and to expand credit to support economic growth. At this juncture, in light of the fast moving developments in financial markets, it is essential to deal with the crisis at hand. Certainly, the shortcomings and weaknesses of our financial markets and regulatory system must be addressed if we are to avoid a repetition of what has transpired in our financial markets over the past year. However, the development of a comprehensive proposal for reform will require a careful and extensive analysis that would be difficult to compress into the short legislative timeframe now available. Looking forward, the Federal Reserve is committed to working closely with the Congress, the Administration, Federal regulators, and other stakeholders in developing a stronger, more resilient, and better regulated financial system. Thank you, Mr. Chairman. [The prepared statement of Chairman Bernanke can be found on page 82 of the appendix.] " FOMC20071031meeting--75 73,VICE CHAIRMAN GEITHNER.," As the Chairman said at the Economic Club of New York, it is likely to emerge stronger. I think the outlook looks about the way it did in September. Just a few quick points. Financial market conditions are substantially better than during the peak of the panic in mid-August; but the improvement, as many of you said, is still quite limited and uneven. Sentiment is still quite fragile, and I think we still seem likely to face a protracted period of adjustment ahead as the markets work through the substantial array of challenges remaining. Growth in the United States and in the world economy in my view seems likely to slow— more here, of course, than elsewhere. Here, even though the nonhousing, non-auto parts of the U.S. economy don’t yet show significant evidence of a considerable slowdown of actual or expected demand, I think that still seems likely. In our central scenario, though, housing construction weakens further. Housing demand slows further because of the tightening of credit conditions. Prices fall further. Consumer spending slows a bit, and businesses react by scaling back growth in hiring and investment, and this produces several quarters of growth modestly below trend. I think that growth outside the United States is likely to slow a bit. It will slow toward potential, if not all the way to potential, in those economies that have been growing above potential. Although the world is larger in relative terms and somewhat less vulnerable to a U.S. slowdown than it once was, it seems to me very unlikely that domestic demand in the rest of the world will accelerate as domestic demand slows in the United States. So the risks to this outlook for U.S. growth still seem to lie to the downside. The magnitude of the downside risks may be slightly less than in September, but they remain substantial. I think the main source of this downside risk to growth is the interaction between expectations of recession probability and the credit market dynamics. Each feeds the other. As the outlook for housing deteriorates and the recession probability stays elevated, financial institutions and investors stay cautious. That caution, in turn, slows the pace of recovery in markets—in asset-backed, securitization, and structured-credit markets—and in credit growth more broadly. As expectations adjust to anticipate a longer, more-substantial period of impairment in markets, then recession probability at least potentially increases. I think that the underlying inflation numbers and the measures we use to capture underlying inflation do not suggest any meaningful acceleration in underlying inflation, and we still expect the core PCE to run at a rate below 2 percent over the forecast period. In some ways, though, the inflation outlook now feels a bit worse. It feels worse because of the modest rise in breakevens that we saw following our last meeting and because of sentiment in markets around gold, commodity and energy prices, and the dollar. The fact that breakevens at long horizons have risen or failed to fall as monetary policy expectations have shifted down is not the most comforting pattern out there. So I think we need to be very careful not to encourage any sense in markets that we’re indifferent to those potential risks. Having said that, I think the risks to that inflation forecast are roughly balanced. The range of tools we have for measuring equilibrium combined with what you see in financial market expectations suggests that monetary policy, to assess the real short-term interest rate, is at or above most estimates of neutral and, therefore, is still exerting some modest restraint on growth. The expectations now built into markets imply too much easing over the next eighteen months, more than I think we’re likely to have to do. But I think the appropriate path of monetary policy lies under the Greenbook’s assumption. Thank you." CHRG-110shrg50417--14 STATEMENT OF SENATOR CHARLES E. SCHUMER Senator Schumer. Thank you, Mr. Chairman. I want to thank you for your diligence throughout this period of holding a whole series of hearings. It is vital that we make sure that the programs implemented by Treasury and the Federal Reserve are accomplishing the goals of restoring our financial system and our economy, and these hearings play a major role in that, so I thank you. Now, although we seem to have avoided the devastating effects of a full-fledged depression through the recent emergency interventions, particularly the Government backing interbank lending and business deposits at banks, we still face frozen credit markets for consumers and businesses as well as a recession that threatens to be too long and too painful for the entire country. I am glad that Secretary Paulson and the rest of the Treasury team have finally seen the light and decided to abandon asset purchases. It was the worst-kept secret in Washington that the asset purchases and the auctions Treasury proposed would not work and were likely to be scrapped. During the entire negotiations, from the days you and I, Mr. Chairman, and some of the others sat across the table, Treasury never figured out how to price the assets, whether by auction or by purchase. So it was just a matter of time until Secretary Paulson finally acknowledged that reality, and I am glad he did so we could move on. Now, many of my colleagues and I recognized that capital injections were clearly the correct approach from the beginning, and we gave Secretary Paulson the authority to do them without him asking for them. Now I suspect he is grateful we did, since it has become the most indispensable tool to restore confidence in our financial system, and I am glad we have moved away from auction and asset purchase and to capital injection. But the Capital Injection Program is not working either, not because there is a fundamental flaw in the concept of capital injection, but because of the way the program is structured. Because of the way it is structured, it is not meeting its goals of improving stability in the system and increasing lending the way it should. Treasury's stated purpose for the capital injections was to give banks a strong capital base so that they could increase lending into the economy for things like credit cards, auto loans, and small business loans. But in these uncertain and difficult times where nobody is sure of asset values, banks are inclined to hoard rather than deploy capital. They do not know how much lower the value of the assets they have will go, so they are hoarding the new capital in case they go lower. And in its zeal to include the largest banks and avoid any stigma in participating, Treasury failed to make the rules strict enough to overcome that inclination. And as a result, the Capital Injection Program is not producing very much new lending. Even if Treasury may not be able--now I intend to ask the witnesses here from the banks why they are not lending more with this additional capital. But even if Treasury cannot change the terms retroactively, any new capital injection must come with tougher requirements. Treasury should revise the terms for the next $125 billion, and if they come to us and ask us for the additional $350 billion, I intend to write those provisions--do my best with, I know, the support of many of my colleagues here, to put those provisions into the new terms of the law. Because consumers and businesses around the country depend on credit, if it is not available, the recession will be deeper and longer than it has to be. And yesterday Secretary Paulson said, well, let us focus on auto loans and credit card loans and small business loans. But he is ignoring the best way to get to do it, which is through the Capital Injection Program, but a Capital Injection Program with some stringency, with making sure that the institutions who take it--and I am against forcing institutions to take it; I think that was a bad idea--but that those who take it, need it, should have to meet some requirements. It is particularly true for small businesses that need credit to expand and create jobs. I just got a call yesterday and saw up in Buffalo a company of 300 employees, been there for a long time, cannot get a loan. Good-paying jobs in Buffalo, they do not come easy, and they are ready to go under even though the firm has been in business for a long time. And I am sure that story can be repeated in every one of our States over and over and over again. Small businesses need credit to expand and create jobs. They also need it to keep their doors open to protect the jobs they have. Millions more jobs could be in jeopardy if we do not fix the lending markets, and fast. The Federal Reserve Quarterly Lending Report for the third quarter reported that 75 percent of banks have tightened credit on commercial and industrial loans to small firms during the third quarter. That was up from 65 percent in the second quarter and 50 percent in the first. So Senator Kerry and I have been working on adding some targeted small business items to the stimulus package, such as temporarily waiving all lender and borrower fees, and increasing the maximum loan amount, and I will be asking these questions in addition to encourage banks to lend to small business as larger banks. I also believe, as some have stated--I think you, Mr. Chairman, and I could not agree with you more--that tougher terms should include more stringent restrictions on executive compensation to ensure that there are not incentives for executives to take excessive risk and more help for struggling homeowners. Chairman Bair's proposal in combination with the change in bankruptcy laws--and I believe this will only work if we change the bankruptcy laws--is the clearest and cleanest solution. One more point, Mr. Chairman. It is critical that we ensure the Government's capital is not wasted in other ways. I am calling for any mergers completed with the help of TARP money first to be approved by Treasury. And this relates to my colleague from Ohio's point. While there are mergers that should take place to improve systemic stability and encourage lending, in a very weak institution a merger may be the right way to go. Giving away Government money so that it can be used to gobble up competitors in a way that will not have any impact on the overall stability of the financial sector should not be endorsed. Mr. Chairman, the Government's assistance has to include significant help from Main Street as well as Wall Street. Consumers and businesses must see improved access to credit as a result of the Government's actions, and struggling homeowners must see a renewed commitment from the Government to help them avoid foreclosure. I look forward to discussing these issues with the panel, and thank you for holding the hearing. " CHRG-110shrg50369--14 Mr. Bernanke," I will conclude with a quick update on the Federal Reserve's recent actions to help protect consumers in their financial dealings. The economic situation has become distinctly less favorable since the time of our July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses. The growth of real gross domestic product held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the unemployment rate--at 4.9 percent in January--has moved up somewhat. Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and sales of new homes are now less than half of their respective peaks, and house prices have flattened or declined in many areas. Changes in the availability of mortgage credit amplified the swings in the housing market. During the housing sector's expansion phase, increasingly lax lending standards, particularly in the subprime market, raised the effective demand for housing, pushing up prices and stimulating construction activity. As the housing market began to turn down, however, the slump in subprime mortgage originations, together with a more general tightening of credit conditions, has served to increase the severity of the downturn. Weaker house prices in turn have contributed to the deterioration in the performance of mortgage-related securities and reduced the availability of mortgage credit. The housing market is expected to continue to weigh on economic activity in coming quarters. Home builders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries. Consumer spending continued to increase at a solid pace through much of the second half of 2007, despite the problems in the housing market, but it appears to have slowed significantly toward the end of the year. The jump in the price of imported energy, which eroded real incomes and wages, likely contributed to the slowdown in spending, as did the declines in household wealth associated with the weakness in house prices and equity prices. Slowing job creation is yet another potential drag on household spending, as gains in payroll employment averaged little more than 40,000 per month during the 3 months ending in January, compared with an average increase of almost 100,000 per month over the previous 3 months. However, the recently enacted fiscal stimulus package should provide some support for household spending during the second half of this year and into next year. The business sector has also displayed signs of being affected by the difficulties in the housing and credit markets. Reflecting a downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that investment in equipment and software will be subdued during the first half of 2008. Likewise, after growing robustly through much of 2007, nonresidential construction is likely to decelerate sharply in coming quarters as business activity slows and funding becomes harder to obtain, especially for more speculative projects. On a more encouraging note, we see few signs of any serious imbalances in business inventories aside from the overhang of unsold homes. And, as a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid balance sheets, and corporate leverage near historical lows. In addition, the vigor of the global economy has offset some of the weakening of domestic demand. U.S. real exports of goods and services increased at an annual rate of about 11 percent in the second half of last year, boosted by continuing economic growth abroad and the lower foreign exchange value of the dollar. Strengthening exports, together with moderating imports, have in turn led to some improvement in the U.S. current account deficit, which likely narrowed in 2007--on an annual basis--for the first time since 2001. Although recent indicators point to some slowing of foreign economic growth, U.S. exports should continue to expand at a healthy pace in coming quarters, providing some impetus to domestic economic activity and employment. As I have mentioned, financial markets continue to be under considerable stress. Heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. However, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker outlook for economic growth, have also roiled the financial markets in recent months. To help relieve the pressures in the market for interbank lending, the Federal Reserve--among other actions--recently introduced a term auction facility, through which prespecified amounts of discount window credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will continue to monitor financial developments closely. As part of its ongoing commitment to improving the accountability and public understanding of monetary policymaking, the Federal Open Market Committee--or FOMC--recently increased the frequency and expanded the content of the economic projections made by Federal Reserve Board members and Reserve Bank presidents and released to the public. The latest economic projections, which were submitted in conjunction with the FOMC meeting at the end of January and which are based on each participant's assessment of appropriate monetary policy, show that real GDP was expected to grow only sluggishly in the next few quarters and that the unemployment rate was likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to grow between 1.3 percent and 2.0 percent in 2008, down from 2\1/2\ percent to 2\3/4\ percent projected in our report last July. FOMC participants' projections for the unemployment rate in the fourth quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the level of about 4\3/4\ percent projected last July for the same period. The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or a little above its longer-term trend and the unemployment rate edging lower; the improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish economic activity in the near term. The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or the labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further. Consumer price inflation has increased since our previous report, in substantial part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated. Reflecting these influences, the price index for personal consumption expenditures--or PCE--increased 3.4 percent over the four quarters of 2007, up from 1.9 percent in 2006. Core price inflation--that is, inflation excluding food and energy prices--also firmed toward the end of the year. The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices. Moreover, core inflation in the first half of 2007 was damped by a number of transitory factors--notably, unusually soft prices for apparel and for financial services--which subsequently reversed. For the year as a whole, however, core PCE prices increased 2.1 percent, down slightly from 2006. The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent--the central tendency of the projections. A key assumption underlying those projections was that energy and food prices would begin to flatten out, as implied by quotes on futures markets. In addition, diminishing pressure on resources is also consistent with the projected slowing in inflation. The central tendency of the projections for core PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-than-expected recent readings on prices. Beyond 2008, both overall and core inflation were projected to edge lower, as participants expected inflation expectations to remain reasonably well anchored and pressures on resource utilization to be muted. The inflation projections submitted by FOMC participants for 2010--which ranged from 1.5 percent to 2.0 percent for overall PCE inflation--were importantly influenced by participants' judgments about the measured rates of inflation consistent with the Federal Reserve's dual mandate and about the timeframe over which policy should aim to achieve those rates. The rate of inflation that is actually realized will, of course, depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of domestic resource utilization fall more than we currently expect. Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month. Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored. Any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and could reduce the flexibility of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead, the Federal Reserve will continue to monitor closely inflation and inflation expectations. Let me turn now to the implications of these developments for monetary policy. The FOMC has responded aggressively to the weaker outlook for economic activity, having reduced its target for the Federal funds rate by 225 basis points since last summer. As the Committee noted in its most recent post-meeting statement, the intent of those actions has been to help promote moderate growth over time and to mitigate the risks to economic activity. A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures. In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as by the risks to that forecast. Although the FOMC participants' economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks. Finally, I would like to say a few words about the Federal Reserve's recent actions to protect consumers in their financial transactions. In December, following up on a commitment I made at the time of our report last July, the Board issued for public comment a comprehensive set of new regulations to prohibit unfair or deceptive practices in the mortgage market, under the authority granted us by the Home Ownership and Equity Protection Act of 1994. The proposed rules would apply to all mortgage lenders and would establish lending standards to help ensure that consumers who seek mortgage credit receive loans whose terms are clearly disclosed and that can reasonably be expected to be repaid. Accordingly, the rules would prohibit lenders from engaging in a pattern or practice of making higher-priced mortgage loans without due regard to consumers' ability to make the scheduled payments. In each case, a lender making a higher-priced loan would have to use third-party documents to verify the income relied on to make the credit decision. For higher-priced loans, the proposed rules would require the lender to establish an escrow account for the payment of property taxes and homeowners' insurance and would prevent the use of prepayment penalties in circumstances where they might trap borrowers in unaffordable loans. In addition, for all mortgage loans, our proposal addresses misleading and deceptive advertising practices, requires borrowers and brokers to agree in advance on the maximum fee that the broker may receive, bans certain practices by servicers that harm borrowers, and prohibits coercion of appraisers by lenders. We expect substantial public comment on our proposal, and we will carefully consider all information and viewpoints while moving expeditiously to adopt final rules. The effectiveness of the new regulations, however, will depend critically on strong enforcement. To that end, in conjunction with other Federal and State agencies, we are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons learned and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for, all categories of mortgage lenders. The Federal Reserve continues to work with financial institutions, public officials, and community groups around the country to help homeowners avoid foreclosures. We have called on mortgage lenders and servicers to pursue prudent loan workouts and have supported the development of a streamlined, systematic approach to expedite the loan modification process. We also have been providing community groups, counseling agencies, regulators, and others with detailed analyses to help identify neighborhoods at high risk from foreclosures so that local outreach efforts to help troubled borrowers can be as focused and effective as possible. We are actively pursuing other ways to leverage the Federal Reserve's analytical resources, regional presence, and community connections to address this critical issue. In addition to our consumer protection efforts in the mortgage area, we are working toward finalizing rules under the Truth in Lending Act that will require new, more informative, and consumer-tested disclosures by credit card issuers. Separately, we are actively reviewing potentially unfair and deceptive practices by issuers of credit cards. Using the Board's authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring. Thank you. I would be pleased to take your questions. " CHRG-111shrg51303--28 Mr. Kohn," Mr. Chairman, I agree that the Federal Reserve needs to think very carefully about what it is revealing, the transparency of its operations across a broad range of our operations today. We are in a new world and new types of transparency are required. In fact, Chairman Bernanke has put me in charge of a committee to look at how we can be more transparent about a variety of our operations. With regard to these particular operations, there are a lot of counterparties benefiting from the efforts of the government and the Federal Reserve to stabilize AIG, not just a few, but many of the pension funds, households, businesses, and people with insurance policies, 401(k)s, et cetera, and a whole variety of counterparties here. These counterparties, I think, entered into their transactions with AIG as normal commercial transactions, expecting confidentiality, as you would in a normal commercial transaction. In fact, AIG and the Federal Reserve went to these counterparties to tear up the credit default swap arrangements because they were draining liquidity from the company, and we thought that canceling those arrangements, buying the CDOs, would protect the taxpayers and stabilize the company as best we could under those circumstances. So they didn't approach us and say, we want to tear up these contracts. We approached them because we were trying to help the company and help the U.S. taxpayer and take some of the downside risk off AIG's balance sheet. I would be very concerned that if we started revealing lists of names who did transactions with companies who later came under government protection, got capital, that sort of thing, that people just wouldn't want to do transactions with companies. We need AIG to be a vital part of our credit markets. As you said, Mr. Chairman, insurance companies are absolutely essential to keeping credit flowing. We need AIG to be stable and to continue in a stable condition, and I would be very concerned that if we started giving out the name of counterparties here, people wouldn't want to do business with AIG. We need people to do---- " fcic_final_report_full--435 TURNING BAD MORTGAGES INTO TOXIC FINANCIAL ASSETS The mortgage securitization process turned mortgages into mortgage-backed securi- ties through the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, as well as Countrywide and other “private label” competitors. The securitiza- tion process allows capital to flow from investors to homebuyers. Without it, mort- gage lending would be limited to banks and other portfolio lenders, supported by traditional funding sources such as deposits. Securitization allows homeowners ac- cess to enormous amounts of additional funding and thereby makes homeownership more affordable. It also can diversify housing risk among different types of lenders. If everything else is working properly, these are good things. Everything else was not working properly. Some focus their criticism on the form of these financial instruments. For exam- ple, financial instruments called collateralized debt obligations (CDOs) were engi- neered from different bundled payment streams from mortgage-backed securities. Some argue that the conversion of a bundle of simple mortgages to a mortgage- backed security, and then to a collateralized debt obligation, was a problem. They ar- gue that complex financial derivatives caused the crisis. We conclude that the details of this engineering are incidental to understanding the essential causes of the crisis. If the system works properly, reconfiguring streams of mortgage payments has little ef- fect. The total amount of risk in a mortgage is unchanged if the pieces are put to- gether in a different way. Unfortunately, the system did not work as it should have. There were several flaws in the securitization and collateralization process that made things worse. • Fannie Mae and Freddie Mac, as well as Countrywide and other private label competitors, all lowered the credit quality standards of the mortgages they se- curitized.  A mortgage-backed security was therefore “worse” during the crisis than in preceding years because the underlying mortgages were generally of poorer quality. This turned a bad mortgage into a worse security. • Mortgage originators took advantage of these lower credit quality securitization standards and the easy flow of credit to relax the underwriting discipline in the loans they issued. As long as they could resell a mortgage to the secondary mar- ket, they didn’t care about its quality. • The increasing complexity of housing-related assets and the many steps be- tween the borrower and final investor increased the importance of credit rating agencies and made independent risk assessment by investors more difficult. In this respect, complexity did contribute to the problem, but the other problems listed here are more important. • Credit rating agencies assigned overly optimistic ratings to the CDOs built from mortgage-backed securities.  By erroneously rating these bundles of mortgage-backed security payments too highly, the credit rating agencies sub- stantially contributed to the creation of toxic financial assets. • Borrowers, originators, securitizers, rating agencies, and the ultimate buyers of the securities into which the risky mortgages were packaged all failed to exer- cise prudence and perform due diligence in their respective transactions. In particular, CDO buyers who were, in theory, sophisticated investors relied too heavily on credit ratings. • Many financial institutions chose to make highly concentrated bets on housing prices. While in some cases they did that with whole loans, they were able to more easily and efficiently do so with CDOs and derivative securities. • Regulatory capital standards, both domestically and internationally, gave pref- erential treatment to highly rated debt, further empowering the rating agencies and increasing the desirability of mortgage-backed structured products. • There is a way that housing bets can be magnified using a form of derivative. A synthetic CDO is a security whose payments mimic that of a CDO that contains real mortgages. This is a “side bet” that allows you to assume the same risk as if you held pieces of actual mortgages. To the extent that investors and financial institutions wanted to increase their bets on housing, they were able to use syn- thetic CDOs. The risks in these synthetic CDOs, however, are zero-sum, since for every investor making a bet that housing performance will fall there must be other investors with equal-sized bets in the opposite direction. FinancialCrisisInquiry--677 CLOUTIER: Correct. I mean, you know, one example is if they had to live with my capital levels. I had 12 percent capital. When I heard them talk about their capital levels here earlier today, I wondered how in the world they got away with that. Because I guarantee you, if I walked and told my regulator I was going to have 6 percent capital, I’d have a C&D in the morning on my desk. You know, it’s an unfair system. So when they say send more regulation, more regulation only means that’s more stuff that I don’t have to worry about and that’s an easy way to go out the back door. You know, when we had the crisis at Enron, they passed—which by the way, Citicorp and them were deeply involved in. You know, they paid big fines for. It didn’t affect them at all. It was crushing to small business. It was a crushing event. Gramm-Leach-Bliley, when they changed the rules, it didn’t affect them. It affected us. So more regulation usually doesn’t have much effect. My question is, and the question this commission should ask: Why wasn’t the regulations on the books enforced? And then that would be an amazing question to ask. And I think most of the answer is is that they’re a member of the FAC they’re very closely interlinked into the Washington circles. CHRG-110hhrg38392--66 Mr. Gutierrez," Thank you very much. Welcome back, Chairman Bernanke. Just a side note, as Chairman, when you get together with the Governors, you might want to take a look at what I feel is going to be a real looming crisis, and that is for our generation of college kids today, because there is not a week that goes by that my daughter does not get another credit card. Worse yet, now she is getting loans to take a vacation, and to get a laptop. I mean, you should see the stuff that is coming in the mail. Fortunately, she has a very fiscally responsible dad who has taught her about money and monetary policy, at least I hope so, until I get the credit card bill in the mail. Very seriously, I really fear this can get out of hand, especially with the rising costs of how young people are going to manage their college. I would hate to see the next generation in such debt, but no matter what monetary policy you come up with, we are not going to be very helpful to them. Chairman Bernanke, at the February hearing, in response to a question from my good friend Congressman Cleaver regarding the positive role that immigrants have played and continue to play in our economy, you comment briefly on immigration reform. You state, ``So I certainly agree that immigrants have played a big role, they continue to play a big role, and we need to have a national policy on that. This is a very tough issue, and I think Congress really has to take the lead about how many people and under what conditions we admit, but it certainly is the case today that immigrants are playing a major role in our economy. There is no question about that.'' I appreciate your response, and agree with you in many respects, and I am not trying to play ``gotcha'' here by asking you to endorse any particular panacea--you just answered the last question in that regard--but I would like for you to expand a little bit on part of your answer from February. Specifically, do you think that the uncertainty with respect to the availability of a vibrant workforce created by Congress' failure to act on immigration reform has a negative impact or could have a negative impact on our economy? " CHRG-111hhrg48674--18 Mr. Bernanke," Yes, sir. The terms and conditions, to my knowledge--and if you have any exceptions, I would be glad to get information to you--but the terms and conditions of all our agreements, to my knowledge, are fully disclosed. There are two types. There are the lending programs, such as the discount window and commercial paper facility. Those are all public information and all on the Web site. The testimony has a list of 5 pages of Web sites where information can be obtained. That information is fully disclosed. The one-off deals associated with AIG and Bear Stearns likewise, to my knowledge, they are fully disclosed in terms of-- " CHRG-110hhrg46594--410 The Chairman," On page 3 of the bill, we in fact have a section that says, no provision of this title shall be construed as altering, affecting or superseding the provisions of the environmental one. Professor Slaughter, I appreciated your testimony as I have admired much of your work. And I have to say, in your closing comments about the need for a safety net, you immediately qualified as my favorite witness that the Republicans ever suggested that we have. I wish they would send us more like you. But I do have one question, and I would like to do that. There is no question. I think you make a good point. Had we in the past done that on the social sector, this would be an easy decision to make, if people weren't faced with the loss of their health care and if indeed health care had been built into the costs of the car. But I do want to say, there is one argument you made, with all due respect, it seemed to be a little bit of a make waste. That was, that if we do this, other countries will get indignant and be more protectionist. It is not my impression that they have a morally superior position to us today in the automobile industry on the whole with regard to openness to automobiles. That is, I think--no, I don't think anyone--we have about as open an automobile market as you can have. A number of other countries, Korea, China, we have already heard have less of one. I am skeptical that this would be any basis for them being any tougher on our automobile industry than they already are. " CHRG-110shrg50369--143 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System February 28, 2008 Chairman Dodd, Ranking Member Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. In my testimony this morning I will briefly review the economic situation and outlook, beginning with developments in real activity and inflation, then turn to monetary policy. I will conclude with a quick update on the Federal Reserve's recent actions to help protect consumers in their financial dealings. The economic situation has become distinctly less favorable since the time of our July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses. The growth of real gross domestic product (GDP) held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the unemployment rate--at 4.9 percent in January--has moved up somewhat. Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and sales of new homes are now less than half of their respective peaks, and house prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market. During the housing sector's expansion phase, increasingly lax lending standards, particularly in the subprime market, raised the effective demand for housing, pushing up prices and stimulating construction activity. As the housing market began to turn down, however, the slump in subprime mortgage originations, together with a more general tightening of credit conditions, has served to increase the severity of the downturn. Weaker house prices in turn have contributed to the deterioration in the performance of mortgage-related securities and reduced the availability of mortgage credit. The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries. Consumer spending continued to increase at a solid pace through much of the second half of 2007, despite the problems in the housing market, but it appears to have slowed significantly toward the end of the year. The jump in the price of imported energy, which eroded real incomes and wages, likely contributed to the slowdown in spending, as did the declines in household wealth associated with the weakness in house prices and equity prices. Slowing job creation is yet another potential drag on household spending, as gains in payroll employment averaged little more than 40,000 per month during the 3 months ending in January, compared with an average increase of almost 100,000 per month over the previous 3 months. However, the recently enacted fiscal stimulus package should provide some support for household spending during the second half of this year and into next year. The business sector has also displayed signs of being affected by the difficulties in the housing and credit markets. Reflecting a downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that investment in equipment and software will be subdued during the first half of 2008. Likewise, after growing robustly through much of 2007, nonresidential construction is likely to decelerate sharply in coming quarters as business activity slows and funding becomes harder to obtain, especially for more speculative projects. On a more encouraging note, we see few signs of any serious imbalances in business inventories aside from the overhang of unsold homes. And, as a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid balance sheets, and corporate leverage near historical lows. In addition, the vigor of the global economy has offset some of the weakening of domestic demand. U.S. real exports of goods and services increased at an annual rate of about 11 percent in the second half of last year, boosted by continuing economic growth abroad and the lower foreign exchange value of the dollar. Strengthening exports, together with moderating imports, have in turn led to some improvement in the U.S. current account deficit, which likely narrowed in 2007 (on an annual basis) for the first time since 2001. Although recent indicators point to some slowing of foreign economic growth, U.S. exports should continue to expand at a healthy pace in coming quarters, providing some impetus to domestic economic activity and employment. As I have mentioned, financial markets continue to be under considerable stress. Heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. However, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker outlook for economic growth, have also roiled the financial markets in recent months. To help relieve the pressures in the market for interbank lending, the Federal Reserve--among other actions--recently introduced a term auction facility (TAF), through which prespecified amounts of discount window credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will continue to monitor financial developments closely. As part of its ongoing commitment to improving the accountability and public understanding of monetary policy making, the Federal Open Market Committee (FOMC) recently increased the frequency and expanded the content of the economic projections made by Federal Reserve Board members and Reserve Bank presidents and released to the public. The latest economic projections, which were submitted in conjunction with the FOMC meeting at the end of January and which are based on each participant's assessment of appropriate monetary policy, show that real GDP was expected to grow only sluggishly in the next few quarters and that the unemployment rate was seen as likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to grow between 1.3 percent and 2.0 percent in 2008, down from 2\1/2\ percent to 2\3/4\ percent projected in our report last July. FOMC participants' projections for the unemployment rate in the fourth quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the level of about 4\3/4\ percent projected last July for the same period. The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or a little above its longer-term trend and the unemployment rate edging lower; the improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish economic activity in the near term. The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further. Consumer price inflation has increased since our previous report, in substantial part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated. Reflecting these influences, the price index for personal consumption expenditures (PCE) increased 3.4 percent over the four quarters of 2007, up from 1.9 percent in 2006. Core price inflation--that is, inflation excluding food and energy prices--also firmed toward the end of the year. The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices. Moreover, core inflation in the first half of 2007 was damped by a number of transitory factors--notably, unusually soft prices for apparel and for financial services--which subsequently reversed. For the year as a whole, however, core PCE prices increased 2.1 percent, down slightly from 2006. The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent (the central tendency of the projections). A key assumption underlying those projections was that energy and food prices would begin to flatten out, as was implied by quotes on futures markets. In addition, diminishing pressure on resources is also consistent with the projected slowing in inflation. The central tendency of the projections for core PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-than-expected recent readings on prices. Beyond 2008, both overall and core inflation were projected to edge lower, as participants expected inflation expectations to remain reasonably well-anchored and pressures on resource utilization to be muted. The inflation projections submitted by FOMC participants for 2010--which ranged from 1.5 percent to 2.0 percent for overall PCE inflation--were importantly influenced by participants' judgments about the measured rates of inflation consistent with the Federal Reserve's dual mandate and about the time frame over which policy should aim to attain those rates. The rate of inflation that is actually realized will of course depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of domestic resource utilization fall more than we currently expect. Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month. Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored. Any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and could reduce the flexibility of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead, the Federal Reserve will continue to monitor closely inflation and inflation expectations. Let me turn now to the implications of these developments for monetary policy. The FOMC has responded aggressively to the weaker outlook for economic activity, having reduced its target for the federal funds rate by 225 basis points since last summer. As the Committee noted in its most recent post-meeting statement, the intent of those actions has been to help promote moderate growth over time and to mitigate the risks to economic activity. A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures. In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast. Although the FOMC participants' economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks. Finally, I would like to say a few words about the Federal Reserve's recent actions to protect consumers in their financial transactions. In December, following up on a commitment I made at the time of our report last July, the Board issued for public comment a comprehensive set of new regulations to prohibit unfair or deceptive practices in the mortgage market, under the authority granted us by the Home Ownership and Equity Protection Act of 1994. The proposed rules would apply to all mortgage lenders and would establish lending standards to help ensure that consumers who seek mortgage credit receive loans whose terms are clearly disclosed and that can reasonably be expected to be repaid. Accordingly, the rules would prohibit lenders from engaging in a pattern or practice of making higher-priced mortgage loans without due regard to consumers' ability to make the scheduled payments. In each case, a lender making a higher priced loan would have to use third-party documents to verify the income relied on to make the credit decision. For higher-priced loans, the proposed rules would require the lender to establish an escrow account for the payment of property taxes and homeowners' insurance and would prevent the use of prepayment penalties in circumstances where they might trap borrowers in unaffordable loans. In addition, for all mortgage loans, our proposal addresses misleading and deceptive advertising practices, requires borrowers and brokers to agree in advance on the maximum fee that the broker may receive, bans certain practices by servicers that harm borrowers, and prohibits coercion of appraisers by lenders. We expect substantial public comment on our proposal, and we will carefully consider all information and viewpoints while moving expeditiously to adopt final rules. The effectiveness of the new regulations, however, will depend critically on strong enforcement. To that end, in conjunction with other federal and state agencies, we are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons learned and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for, all categories of mortgage lenders. The Federal Reserve continues to work with financial institutions, public officials, and community groups around the country to help homeowners avoid foreclosures. We have called on mortgage lenders and servicers to pursue prudent loan workouts and have supported the development of streamlined, systematic approaches to expedite the loan modification process. We also have been providing community groups, counseling agencies, regulators, and others with detailed analyses to help identify neighborhoods at high risk from foreclosures so that local outreach efforts to help troubled borrowers can be as focused and effective as possible. We are actively pursuing other ways to leverage the Federal Reserve's analytical resources, regional presence, and community connections to address this critical issue. In addition to our consumer protection efforts in the mortgage area, we are working toward finalizing rules under the Truth in Lending Act that will require new, more informative, and consumer-tested disclosures by credit card issuers. Separately, we are actively reviewing potentially unfair and deceptive practices by issuers of credit cards. Using the Board's authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring. Thank you. I would be pleased to take your questions. FinancialCrisisInquiry--136 CHAIRMAN ANGELIDES: I’ll—this discussion is going well. I’ll yield three, four minutes. You tell me what you need. I’ve got flexibility this time. MURREN: That should be perfect. CHAIRMAN ANGELIDES: Fine. Let’s do three minutes and see how it goes. And we’ll go from there. MURREN: You mentioned that you disagreed with Mr. Dimon on that particular point. I’m curious maybe if you could each just briefly mention what you most agree with that they said— the previous panelists. And I’m assuming that you had an opportunity to hear their testimony. And then, perhaps, maybe one or two things that you disagreed with. MAYO: You know, as I listened to Mr. Blankfein, he brought up one word that hit me that I think, if I’m still doing this job 20 years from now, is going to stick with me. And that’s when he said, “rationalized.” We rationalized what we were doing based on the circumstances at the time. And I think one of the conclusions of your hearings throughout this year, that’s a warning to the future. Look how much we rationalized the activities that were taking place in the industry. So I very much agreed with that. And with regard to Morgan Stanley, Mr. Mack mentioned there was just too much leverage at the firms. That’s an easy call, and you can certainly track that. Well, let me yield to... SOLOMON: I certainly agree on leverage. They all said there was too much leverage. And I also agree that all their managements failed. So I can agree on both those. FOMC20080310confcall--49 47,VICE CHAIRMAN GEITHNER.," Mr. Chairman, maybe I could say something in response to this. I agree with the concerns expressed about giving access to liquidity when we haven't done it before without a full capacity to affect the supervisory constraints these guys operate under. We are not doing this for them, though. We are doing it because we think it is necessary to help improve market functioning more generally. We do not have the capacity in these circumstances to redesign the regulatory framework to give us, as a condition of access to something that we are doing for market functioning, the ability to affect and constrain the risktaking behavior of those institutions. All primary dealers, except for one, I believe, are subject to consolidated supervision in some form. Those primary supervisors, with which we have a very close-running relationship, often subject those institutions to a set of constraints, including in the investment banks a consolidated capital regime and a set of other constraints on liquidity. We will, of course, be in very close contact, as we have been with those primary supervisors, about the evolving financial conditions of those institutions. If we have evidence, directly or through the supervisors, of some material erosion in the financial business of those institutions from a solvency perspective, that will cause us to reflect on what we do with those institutions going forward. I wish it were the case that we could condition this step on a change in the regulatory regime that would give us that capacity. But we just don't have that ability now. Are we protecting ourselves carefully against that risk? We are protecting ourselves carefully, but not perfectly, against that risk. One last comment. The Desk has a lot of experience in affecting the incentive that primary dealers have--how much they can actually bid for, particularly in circumstances where the condition of the primary dealer is eroding quickly. That is not perfect, but it gives us some experience and some chance to make sure that we don't put ourselves in a position where we allow an institution that is deteriorating rapidly to take a progressively larger amount of a particular auction in that context. So although I agree with the concerns and I really am sympathetic to the objective, the reality today is that we can't remake this messy system we have in this context to give us that additional comfort. " CHRG-110hhrg41184--15 Mr. Bernanke," Okay. In my testimony this morning, I will briefly review the economic situation and outlook, beginning with developments in real activity and inflation, and then turn to monetary policy. I will conclude with a quick update on the Federal Reserve's recent actions to help protect consumers in their financial dealings. The economic situation has become distinctly less favorable since the time of our July report. Strains in financial markets, which first became evident late last summer, have persisted, and pressures on bank capital and the continuing poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses. The growth of real gross domestic product held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the unemployment rate, at 4.9 percent in January, has moved up somewhat. Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and sales of new homes are now less than half of their respective peaks, and house prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market. During the housing sector's expansion phase, increasing lax lending standards, particularly in the subprime market, raised the effective demand for housing, pushing up prices and stimulating construction activity. As the housing market began to turn down, however, the slump in subprime mortgage originations, together with the more general tightening of credit conditions, has served to increase the severity of the downturn. Weaker house prices in turn have contributed to the deterioration in the performance of mortgage-related securities and reduced the availability of mortgage credit. The housing market is expected to continue to weigh on economic activity in coming quarters. Home builders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and in closely related industries. Consumer spending continued to increase at a solid pace through much of the second half of 2007, despite the problems in the housing market, but it appears to have slowed significantly toward the end of the year. The jump in the price of imported energy, which eroded real incomes and wages, likely contributed to the slowdown in spending, as did the declines in household wealth associated with the weakness in house prices and equity prices. Slowing job creation is yet another potential drag on household spending, as gains in payroll employment averaged little more than 40,000 per month during the 3 months ending in January, compared with an average increase of almost 100,000 per month over the previous 3 months. However, the recently enacted fiscal stimulus package should provide some support for household spending during the second half of this year and into next year. The business sector has also displayed signs of being affected by the difficulties in the housing and credit markets. Reflecting a downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that investment in equipment and software will be subdued during the first half of 2008. Likewise, after growing robustly through much of 2007, nonresidential construction is likely to decelerate sharply in coming quarters as business activity flows and funding becomes harder to obtain, especially for more speculative projects. On a more encouraging note, we see few signs of any serious imbalances in business inventories, aside from the overhang of unsold homes. And, as a whole, the nonfinancial business sector remains in good financial condition with strong profits, liquid balance sheets, and corporate leverage near historic lows. In addition, the vigor of the global economy has offset some of the weakening of domestic demand. U.S. real exports of goods and services increased at an annual rate of about 11 percent in the second half of last year, boosted by continuing economic growth abroad and the lower foreign exchange value of the dollar. Strengthening exports, together with moderating imports, have in turn led to some improvement in the U.S. current account deficit, which likely narrowed in 2007 on an annual basis for the first time since 2001. Although recent indicators point to some slowing of foreign growth, U.S. exports should continue to expand at a healthy pace in coming quarters, providing some impetus to domestic economic activity and employment. As I have mentioned, financial markets continue to be under considerable stress. Heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. However, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker outlook for economic growth, have also roiled the financial markets in recent months. To help relieve the pressures in the market for interbank lending, the Federal Reserve, among other actions, recently introduced a term auction facility through which pre-specified amounts of discount window credit are auctioned to eligible borrowers. And we have been working with other central banks to address market strains that could hamper the achievement of our broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will continue to monitor financial developments closely. As part of its ongoing commitment to improving the accountability and public understanding of monetary policymaking, the Federal Open Market Committee, or FOMC, recently increased the frequency and expanded the content of the economic projections made by Federal Reserve Board members and Reserve Bank presidents and released to the public. The latest economic projections, which were submitted in conjunction with the FOMC meeting at the end of January, and which are based on each participant's assessment of appropriate monetary policy, show that real GDP was expected to grow only sluggishly in the next few quarters, and that the unemployment rate was seen as likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to grow between 1.3 percent and 2.0 percent in 2008, down from 2.5 percent to 2.75 percent as projected in our report last July. FOMC participants' projections for the unemployment rate in the fourth quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the level of about 4.75 percent projected last July for the same period. The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or a little above its longer-term trend, and the unemployment rate edging lower. The improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish economic activity in the near term. The risks to this outlook remain to the downside. Those risks include the possibilities that the housing market or the labor market may deteriorate more than is currently anticipated, and that credit conditions may tighten substantially further. Consumer price inflation has increased since our previous report, in substantial part because of the steep run-up in the price of oil. Last year food prices also increased significantly, and the dollar depreciated. Reflecting these influences, the price index for Personal Consumption Expenditures increased by 3.4 percent over the four quarters of 2007, up from 1.9 percent in 2006. Core price inflation, that is, inflation excluding food and energy prices, also firmed toward the end of the year. The higher recent readings likely reflected some pass-through of energy costs to the prices of consumer goods and services, as well as the effect of the depreciation of the dollar and import prices. Moreover, core inflation in the first half of 2007 was damped by a number of transitory factors; notably, unusually soft prices for apparel and for financial services, which subsequently reversed. For the year as a whole, however, core PCE prices increased by 2.1 percent, down slightly from 2006. The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent, the central tendency of the projections. A key assumption underlying those projections was that energy and food prices would begin to flatten out, as was implied by quotes on futures markets. In addition, diminishing pressure on resources is also consistent with the projected slowing in inflation. The central tendency of the projections for core PCE inflation in 2008 at 2.0 percent to 2.2 percent was a bit higher than in our July report, largely because of some higher-than-expected recent readings on prices. Beyond 2008, both overall and core inflation were projected to edge lower as participants expected inflation expectations to remain reasonably well anchored and pressures on resource utilization to be muted. The inflation projection submitted by FOMC participants for 2010, which range from 1.5 percent to 2.0 percent for overall PCE inflation, were importantly influenced by participants' judgments about the measured rates of inflation consistent with the Federal Reserve's dual mandate, and about the timeframe over which policy should aim to attain those rates. The rate of inflation that is actually realized will of course depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities, or if rates of domestic resource utilization fall more than we currently expect. Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out, or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggests slightly greater upside risks to the projections of both overall and core inflation than we saw last month. Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored. Any tendency of inflation expectations to become unmoored, or for the Fed's inflation-fighting credibility to be eroded, could greatly complicate the task of sustaining price stability and could reduce the flexibility of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead, the Federal Reserve will continue to monitor closely inflation and inflation expectations. Let me turn now to the implications of these developments for monetary policy. The FOMC has responded aggressively to the weaker outlook for economic activity, having reduced its target for the Federal funds rate by 225 basis points since last summer. As the committee noted in its most recent post-meeting statement, the intent of those actions has been to help promote moderate growth over time and to mitigate the risk to economic activity. A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risk to growth, stressed financial conditions, and inflation pressures. In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be determined in light of the medium-term forecast of real activity and inflation as well as the risks to that forecast. Although the FOMC participants' economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks. Finally, I would like to say a few words about the Federal Reserve's recent actions to protect consumers in their financial transactions. In December, following up on a commitment I made at the time of our last report in July, the Board issued for public comment a comprehensive set of new regulations to prohibit unfair or deceptive practices in the mortgage market under the authority granted us by the Home Ownership and Equity Protection Act of 1994. The proposed rules would apply to all mortgage lenders and would establish lending standards to help ensure that consumers who seek mortgage credit receive loans whose terms are clearly disclosed and that can reasonably be expected to be repaid. Accordingly, the rules would prohibit lenders from engaging in a pattern or practice of making higher priced mortgage loans without due regard to consumers' ability to make the scheduled payments. In each case, a lender making a higher priced loan would have to use third-party documents to verify the income relied on to make the credit decision. For higher priced loans, the proposed rules would require the lender to establish an escrow account for the payment of property taxes and homeowners insurance, and would prevent the use of prepayment penalties in circumstances where they might trap borrowers in unaffordable loans. In addition, for all mortgage loans, our proposal addresses misleading and deceptive advertising practices, requires borrowers and brokers to agree in advance on the maximum fee that the broker may receive, and certain practices by servicers that harm borrowers and prohibits coercion of appraisers by lenders. We expect substantial public comment on our proposal, and we will carefully consider all information and viewpoints while moving expeditiously to adopt final rules. The effectiveness of the new regulations, however, will depend critically on strong enforcement. To that end, in conjunction with other Federal and State agencies, we are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons learned and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for, all categories of mortgage lenders. The Federal Reserve continues to work with financial institutions, public officials and community groups around the country to help homeowners avoid foreclosures. We have called on mortgage lenders and servicers to pursue prudent loan workouts, and have supported the development of streamlined, systematic approaches to expedite the loan modification process. We have also been providing community groups, counseling agencies, regulators and others with detailed analyses to help identify neighborhoods at high risk for foreclosures so that local outreach efforts to help troubled borrowers can be as focused and as effective as possible. We are actively pursuing other ways to leverage the Federal Reserve's analytical resources, regional presence, and community connections to address this critical issue. In addition to our consumer protection efforts in the mortgage area, we are working towards finalizing rules under the Truth in Lending Act that will require new, more informative, and consumer-tested disclosures by credit card issuers. Separately, we are actively reviewing potentially unfair and deceptive practices by issuers of credit cards. Using the Board's authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring. Thank you. I would be very pleased to take your questions. [The prepared statement of Chairman Bernanke can be found on page 53 of the appendix.] " CHRG-110hhrg44901--8 The Chairman," The Federal Reserve doesn't get to object. Dr. Paul. I think everybody recognizes today that our financial markets are in a big mess, and I have complained for many years about the Federal Reserve System. But I would have to say that Chairman Bernanke himself is not responsible for this mess. Not that I think he has the answers in this deeply flawed monetary system, but obviously the seeds of this mess have been planted over a long period of time. It is more a reflection of the system rather than that of one individual. It is amazing how panicky people have been getting, and how everybody is wringing their hands, and yet our government tells us, well, there is no recession, so things must be all right. A lot of people are very angry. Yet we know there is something seriously wrong, with all the mess that we have in the financial markets. And now we see this morning that inflation is roaring back, yet it is still way below what the private economists are saying about what inflation is really doing. But the consumer knows all about it. It seems like around here, whether it is from Treasury or the Federal Reserve or even in the Congress, all we need now is to have a world-class regulator that is going to solve all our problems, and I think that is so simplistic. From my viewpoint, what we need is a world-class dollar, a dollar that is sound, not a dollar that continues to depreciate, and not a system where we perpetually just resort to inflation and deficit financing to bail out everybody. This is what we have been doing. It hasn't been just with this crisis, but an ongoing crisis. We have been able to pull ourselves out of these nosedives quite frequently. One of the worst with the dollar was in 1979. We patched it together. I think the handwriting on the wall is there is a limit to how many times we can bail the dollar out, because conditions are so much worse today than they have ever been. We talk a lot about predatory lending, but I see the predatory lending coming from the Federal Reserve. Interest at 1 percent, overnight rates, loaning to banks, encouraging the banks and investors to do the wrong things causes all the malinvestment. These conditions were predictable. They were predicted by the Austrian free market economists. It should surprise nobody, yet nobody resorts to looking to those individuals who are absolutely right about what was coming and what we should have done. Even as early as 7 years ago, I introduced legislation that would have removed the line of credit to the Treasury, which was encouraging the moral hazard and the malinvestment. Here, it looks like now we are going to need $300 billion of new appropriations. So we need to look at the monetary system and its basic fundamental flaws that exist there, and then we might get to the bottom of these problems we are facing today. " CHRG-111shrg50815--3 STATEMENT OF SENATOR SHELBY Senator Shelby. Thank you, Chairman Dodd. Although problems with mortgage-related assets have taken center stage in our ongoing financial crisis, credit card lending has also rapidly declined as our economy has deteriorated. The securitization market, a key vehicle for financing credit card transactions, remains severely constrained, at its best. The absence of a robust secondary market has deprived many financial institutions of the financing needed to support credit card-based lending. Unable to securitize their credit card portfolios, many banks have been forced to cut back their customers' credit limits or even terminate their customers' credit cards altogether. In the midst of these challenging market conditions, the Federal Reserve, along with the Office of Thrift Supervision and the National Credit Union Administration, finalized new rules last December that will drastically alter the credit card industry. The rules prohibit a variety of business practices and impose a new layer of complex regulation. They also update and enhance certain consumer protections. The new rules will be implemented over the next year and a half, but already, financial institutions are drastically altering their credit card practices, as they should. Recent reports suggest that the new rules will cause a substantial contraction in consumer credit. While I believe that there are many credit card practices that need reforming, as Senator Dodd mentioned, I also believe that regulators need to be especially careful in this time of financial stress not to take actions that unduly restrict the availability of credit. Limiting the ability of consumers of low and moderate means to obtain credit could have unfortunate consequences. If they can't get credit from regulated banks, they may seek it outside the banking system. Regulators must exercise caution to ensure that the appropriate balance is struck between adequately safeguarding consumers, which is important to all of us, while not eliminating access to credit for millions of American families. Regulators also need to make sure that they do not stifle innovation or unduly restrict consumer choice. Many innovative products that have been demanded by and have benefited consumers, including zero percent financing, may be eliminated or severely curtailed because of the recent regulatory rule changes. We can all agree that abusive products should be addressed, and soon, but we should also be careful not to eliminate legitimate products in doing that. An overly broad approach risks giving consumers a false sense of security. Too often, consumers fail to consider whether a particular financial product is right for them because they believe that Federal regulators have already determined which products are safe and which are dangerous. Yet in many cases, whether a financial product is appropriate for a consumer depends on the consumer's own financial position. If the financial crisis has taught us anything, it is that all sectors of our economy, from big commercial banks to retail consumers, need to do more due diligence before they enter into financial transactions. No regulator can protect a consumer as much as they can protect themselves if they have the necessary information, which is why clear, complete, and understandable disclosure, as Senator Dodd has pushed for years, is so critical. Several bills have been introduced that seek to codify the recent rule changes, and in several instances would go beyond those rules to enact even more severe regulations. I believe before we legislate in this area, I think we should be careful. I would prefer that we give regulators the necessary time to implement the rule changes and then we can evaluate how those rules have worked and what changes are needed. In this time of economic turmoil, we need to proceed carefully, but we do need to proceed. We need to be especially careful not to undermine the ability of our financial system to accurately price risk. The advent of risk-based pricing has helped our financial institutions expand the availability of credit. Undermining the ability of banks to employ risk-based pricing could reverse this very positive development. As this Committee begins to consider regulatory reform, I believe it is important to keep in mind the need to balance carefully our strong desire to protect consumers and the absolute necessity of preserving an innovative and diverse marketplace. These are not mutually exclusive concepts and it is our job--our obligation--to craft a regulatory structure that can accommodate them both, and I hope we will. Senator Johnson. [Presiding.] The Chairman has stepped out momentarily to confer with Secretary Geithner and Mr. Summers. Does anyone want to comment briefly before we get to the panelists? Senator Reed? Senator Reed. I will pass, Mr. Chairman, and defer to my colleagues if they would like to speak. Senator Johnson. Anybody? CHRG-111shrg57321--8 Mr. Kolchinsky," Thank you very much. Good morning. I would like to thank Chairman Levin and the Subcommittee for holding this hearing on the role of the rating agencies in the financial crisis.--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Kolchinsky appears in the Appendix on page 140.--------------------------------------------------------------------------- My name is Eric Kolchinsky, and during the majority of 2007, I was the Managing Director in charge of the business line which rated subprime-backed CDOs at Moody's Investors Service. More recently, I was suspended by Moody's after warning the compliance group regarding what I believed to be a violation of securities laws within the rating agency. In my opinion, the cause of the financial crisis lies primarily with the misaligned incentives in the financial system. Individuals across the financial food chain, from the mortgage broker to the CDO banker, were compensated based on quantity rather than quality. The situation was no different at the rating agencies. It is my firm belief that the vast majority of the analysts at Moody's are honest individuals who try hard to do their jobs. However, the incentives in the market for rating agency services favored, and still favor, short-term profit over credit quality and quantity over quality. At Moody's, the source of this conflict was the quest for market share. Managers of rating groups were expected by their supervisors to build, or at least maintain, market share. It was an unspoken understanding that loss of market share would cause a manager to lose his or her job. Senior management would periodically distribute emails detailing their departments' market share. These emails were limited to managing directors only. Even if the market share dropped by a few percentage points, managers would be expected to justify ``missing'' the deals which were not rated. Colleagues have described enormous pressure when their market shares dipped. While, to my knowledge, senior management never explicitly forced the lowering of credit standards, it was one easy way for a managing director to regain market share. I do not believe that this was done in a deliberate manner. Instead, during the bubble years, it was quite easy to rationalize changes in methodology since the nominal performance of the collateral was often quite exceptional. Easier still was avoiding asking whether the collateral standards had declined or whether some of the parties had ulterior motives in closing the transaction. I began to receive these emails when I was promoted to managing director. They would list all the deals in the market for the relevant period and the amounts rated by Moody's, S&P, and Fitch. I believe that my 2007 dismissal from the rating agency was a consequence of placing credit quality above market share. I was a managing director in the derivatives group, which was responsible for rating CDOs. CDOs were an extremely lucrative area for Moody's: In the first two quarters of 2007, the group generated over $200 million of revenue. This amount accounted for approximately one-fifth of the total revenue of the entire rating agency. However, trouble for the securitization was already brewing. In early 2007, New Century, a major subprime lender, imploded. During the course of the year, the prices of synthetic subprime bonds precipitously declined. The end of this initial phase of the crisis was heralded by the fall of two Bear Stearns hedge funds which heavily invested in CDOs. The resulting price dislocation sent bankers hurrying to finish CDOs already in progress and to clean up their balance sheets. In September 2007, I was told that the ratings of the 2006 vintage of subprime bonds were about to be downgraded severely. While the understaffed RMBS group needed time to determine the new ratings, I left the meeting with the knowledge that the then current ratings were wrong and no longer reflected the best opinion of the rating agency. This information was crucial for the few CDOs in my pipeline, which were being aggressively pushed by bankers. If the underlying ratings were wrong, the ratings on these CDOs would be wrong, also. I believed that to assign new ratings based on assumptions which I knew to be wrong would constitute securities fraud. I immediately notified my manager and proposed a solution to the problem. My manager declined to do anything about the potential fraud, so I raised the issue to a more senior manager. As a result of my intervention, a procedure for lowering subprime bond ratings going into CDOs was announced on September 21, 2007. I believe this action saved Moody's from committing securities fraud. Just about a month later, in mid-October, another periodic market share email was sent to the managing directors in my group. Along with the email, our business manager noted that our market share dropped from 98 percent plus to 94 percent in the third quarter. My manager immediately replied to the email and demanded an accounting of the missing deals. This was the most disturbing email I had ever received in my professional career. A few days before, Moody's had downgraded over $33 billion in subprime bonds. At the time, this was the largest ever single downgrade at Moody's. As a direct result of the October 2007 additional downgrades, over $570 billion of ABS CDOs would be downgraded through the end of 2008. Despite the massive manifest errors in the ratings assigned to structured finance securities and the market implosion we were witnessing, it appeared to me that my manager was more concerned about losing a few points of market share than about violating the law. In late October, less than a month after that email and less than 2 months after I intervened, my manager asked me to leave the group. I was given a smaller position with less responsibility and less pay in a different group. While Moody's has acknowledged that the rating situation in September 2007 constituted a ``problem,'' they failed to act to prevent a nearly identical situation in 2009 in connection with a transaction called Nine Grade Funding. Instead of following some common-sense steps to prevent a violation of the law, Moody's management chose to suspend me after I pointed out the breach. Recent rating activity indicates that market participants still prefer the most aggressive ratings. Rating firms which have taken conservative positions have seen their market shares tumble. We will no doubt see the results of this lesson when the regulatory spotlight is turned off. Credit standards will once again plunge as rating agencies race to build their market share. The only way to prevent this from occurring is to recognize that the function which the rating agencies perform is a quasi-regulatory one, much like accountants. A single set of public standards needs to be implemented, to be used for regulatory purposes only. This will allow rating agencies to compete for clients without being forced to lower credit standards. Thank you very much. Senator Levin. Thank you very much, Mr. Kolchinsky, for that testimony. Dr. Cifuentes.TESTIMONY OF ARTURO CIFUENTES, PH.D.,\1\ FORMER MOODY'S SENIOR VICE PRESIDENT, CURRENT DIRECTOR, FINANCE CENTER, UNIVERSITY OF FinancialCrisisInquiry--105 This is going to be very useful to us. We want to assure you, as we have the administration, that any information provided to us will be handled in the appropriate legal and protective ways, especially sensitive with the private sector on Trade Secrets Act and other information. It’s just that, without your help in follow-up questions that we will ask to get some detailed understanding, that we can provide not just the rough picture of what happened, but a more nuanced, understood, in- depth picture of what happened because, frankly, an argument that I made a lot and then quit making when I was in Congress is that it’s basically you just don’t understand what we’re doing and the context we’re doing it. And I’m sure you’ve heard a lot of that. Our job, hopefully, is to provide as mild and easy a form of education as possible. Just how complicated this world is today and what makes it go round? Your help in that regard, as I said, is invaluable. We’ll ask you questions. We would hope we get a timely response. As we get nearer our time to exist it will be a bit pushier in terms of getting your response. But once again, Mr. Chairman, I want to thank the panel, one for their willingness to come. Two, their openness in response, and three, the answers you’ll be giving us over the course of the next eight months. Thank you very much. CHAIRMAN ANGELIDES: Thank you, Mr. Vice Chairman, members. There is, I know you’ll be glad to know, a little remaining time. So I’d like to just ask a few follow-up questions before we move out of here. And, Mr. Blankfein, maybe you’re going to suffer from me having been A all my life and you having been B, but I do want to revisit some of the issues we talked about. And let me preface this by saying if I die 51 percent right and 49 percent wrong I will be a happy man. FOMC20080310confcall--34 32,CHAIRMAN BERNANKE.," President Plosser, I would make just a couple of comments, and Bill can follow. On the slippery slope, it requires an FOMC vote to add assets. So if we come to that point, you will have your opportunity to vote ""no"" or to object. Again, we don't propose to do that--but, you know, time consistency. I'm sorry, what was the other thing? Oh, you asked about the duration. The section 13(3) legal basis for this operation requires an affirmation that market conditions are significantly impaired. If we couldn't honestly make that affirmation, our legal basis would disappear. So I think we would have to remove it once conditions had normalized. Bill, do you have anything to add to that? " FOMC20070321meeting--216 214,MR. LACKER.," Yes. I’m really sympathetic to Randy’s view about financial conditions. I’m sympathetic about “financial conditions” because I think there’s real potential for confusion in markets about how the phrase relates to policy and whether we might ease if things got too chaotic or volatile. But I agree with President Stern that a little more texture on what we’re doing is fine. I share Governor Kohn’s view that appealing to endogenous variables as if they’re an exogenous cause for belief in support is a little confusing, but in the context I think the reference would be taken to signal that we expect consumption growth to support the expansion. I just wanted to register that." CHRG-111shrg51303--174 PREPARED STATEMENT OF DONALD KOHN Vice Chairman, Board of Governors of the Federal Reserve System March 5, 2009 Chairman Dodd, Ranking Member Shelby, and other Members of the Committee, I appreciate having this opportunity to discuss the role of the Federal Reserve in stabilizing American International Group, Inc. (AIG). In my testimony, I will detail the support the Federal Reserve, working alongside the Treasury, has given AIG and the reasons for each of our actions. Before I go into the extended narrative, however, I think it would be useful to briefly put our decisions in their broader context. Over the past year and a half, we have all been dealing with the ongoing disruptions and pressures engendered by an extraordinary financial crisis. The weaknesses at financial institutions and resulting constraints on credit, declines in asset prices, and erosion of household and business confidence have in turn led to a sharp weakening in the economy. The Federal Reserve has employed all the tools at its disposal to break this spiral and help address the many challenges of the crisis and its effects on the economy. One of the most important of these tools is the Federal Reserve's authority under section 13(3) of the Federal Reserve Act to lend on a secured basis under ``unusual and exigent'' circumstances to companies that are not depository institutions. Since last fall, in order to foster the stability of the financial system and mitigate the effects of ongoing financial stresses on the economy, we have used that authority to help to stabilize the financial condition of AIG. AIG is a widely diversified financial services company that, as of September 30, 2008, which is the reporting date closest to the date we first provided it assistance, reported consolidated total assets of more than $1 trillion. AIG was at that time, and continues to be, one of the largest insurance companies in the world and, in terms of net premiums underwritten, is both the largest life and health insurer in the United States and the second largest property and casualty insurer in the United States. It conducts insurance and finance operations in more than 130 countries and jurisdictions and has more than 74 million individual and corporate customers and 116,000 employees globally. In the United States, it has approximately 30 million customers and 50,000 employees. AIG is the leading commercial insurer in the United States, providing insurance to approximately 180,000 small businesses and other corporate entities, which employ approximately 106 million people in the United States. It is also a major provider of protection to municipalities, pension funds, and other public and private entities through guaranteed investment contracts and products that protect participants in 401(k) retirement plans. AIG has also been a major participant in many derivatives markets through its Financial Products business unit (Financial Products). Financial Products is an unregulated entity that exploited a gap in the supervisory framework for insurance companies and was able to take on substantial risk using the credit rating that AIG received as a consequence of its strong regulated insurance subsidiaries. Financial Products became the counterparty on hundreds of over-the-counter derivatives to a broad range of customers, including many major national and international financial institutions, U.S. pension plans, stable value funds, and municipalities. Financial Products also provided credit protection through credit default swaps it has written on billions of dollars of multi-sector collateralized debt obligations (CDOs). Financial Products did not adequately protect itself against the effects of a declining economy or the loss of the highest ratings from the credit rating agencies, and thereby was a source of weakness to AIG. While Financial Products has been winding down and exiting many of its trades, it continues to have a very large notional amount of derivatives contracts outstanding with numerous counterparties. It is against this background that the Federal Reserve and the Treasury Department have taken a series of unusual actions to stabilize the company. These have entailed very difficult and uncomfortable decisions for a central bank. These decisions were particularly difficult and discomforting because they involved addressing systemic problems created largely by poor decision-making by the company itself. Moreover, many of these decisions involved an unregulated business entity that exploited the strength, and threatened the viability, of affiliates that were large, regulated entities in good standing. However, uncomfortable as this was, we believe we had no choice if we are to pursue our responsibility for protecting financial stability. Our judgment has been and continues to be that, in this time of severe market and economic stress, the failure of AIG would impose unnecessary and burdensome losses on many individuals, households, and businesses; disrupt financial markets; and greatly increase fear and uncertainty about the viability of our financial institutions. Thus, such a failure would deepen and extend market disruptions and asset price declines, further constrict the flow of credit to households and businesses in the United States and in many of our trading partners, and materially worsen the recession our economy is enduring. To mitigate these risks, the Treasury provided equity capital to AIG and the Federal Reserve provided liquidity support backed by the assets of AIG. The Federal Reserve's involvement in AIG began in mid-September of 2008. AIG's financial condition had been deteriorating for some time. The financial and credit markets were experiencing severe stress due to various economic problems arising out of the broad-based decline in home prices, rise in delinquencies and foreclosures, and substantial drop in values of mortgages as well as mortgage-backed securities and other instruments based on such assets. In short-term funding markets, very high spreads between lending rates and the target Federal funds rate and very illiquid trading conditions in term money markets had come to prevail. AIG was exposed to these problems because of the protection Financial Products had written on mortgage-related securities, because of investments AIG had made in mortgage-related securities in connection with its securities lending program, and because its counterparties had begun to withdraw funding. These pressures mounted through September. The private sector worked through the weekend of September 13-14 to find a way for private firms to address AIG's mounting liquidity strains. But that effort was unsuccessful in a deteriorating economic and financial environment in which firms were not willing to expose themselves to risks--a risk aversion that greatly increased following the collapse of Lehman Brothers on September 15. Under these circumstances, on September 16, 2008, acting with the full support of the Treasury, the Board authorized the Federal Reserve Bank of New York (New York Reserve Bank) pursuant to section 13(3) to lend up to $85 billion to AIG through a revolving credit facility (Revolving Credit Facility) in order to ease the liquidity strain on AIG. The liquidity pressures experienced by AIG during that time of fragile economic markets threatened its ability to continue to operate, and the prospect of AIG's disorderly failure posed considerable systemic risks in various ways as a consequence of its significant and wide-ranging operations. Such a failure would also have further undermined business and household confidence and contributed to higher borrowing costs, reduced wealth, and general additional weakening of the economy. Moreover, at the time the Board extended the Revolving Credit Facility, there was no Federal entity that could provide capital to AIG to help stabilize it. The Troubled Asset Relief Program (TARP) legislation was requested in part to fill that void and authorized by Congress on October 3, 2008. The Revolving Credit Facility was established with the purpose of assisting AIG in meeting its obligations when due and facilitating a restructuring whereby AIG would sell certain businesses in an orderly manner, with minimal disruption to the overall economy. AIG would repay the Revolving Credit Facility over a period of two years as it sold assets. Importantly, the Revolving Credit Facility was (and remains) secured by a pledge of a substantial portion of the company's assets, including AIG's ownership interests in its domestic and foreign insurance subsidiaries. As additional compensation for the Revolving Credit Facility, AIG agreed to issue to a trust for the benefit of the Treasury, preferred stock convertible into 79 percent of AIG's outstanding common stock. With these protections, the Board believed that the authorization of the Revolving Credit Facility would not result in any net cost to taxpayers. In connection with the extension of credit, AIG's CEO was replaced. In addition, the New York Reserve Bank established a team to review the financial condition of AIG, and monitor the implementation of AIG's plan to restructure itself and repay the Revolving Credit Facility. Furthermore, as an ongoing condition of the Revolving Credit Facility, the New York Reserve Bank staff established an on-site presence to monitor the company's use of cash flows and progress in pursuing its restructuring and divestiture plan. The Federal Reserve does not have statutory supervisory authority over AIG or its subsidiaries as we would over a bank holding company or State chartered bank that is a member of the Federal Reserve System. Rather, the rights of the Federal Reserve are those typical of a creditor and are governed by the credit agreement for the Revolving Credit Facility. Using these rights, the Federal Reserve works with management of AIG to develop and oversee the implementation of the company's business strategy, its strategy for restructuring, and its new compensation policies, monitors the financial condition of AIG, and must approve certain major decisions that might reduce its ability to repay its loan. The Federal Reserve has a team of about 15 staff members, led by senior officials, who conduct oversight of the company pursuant to the credit agreement. The team has frequent on site contact at the company to make sure the Federal Reserve is adequately informed on funding, cash flows, liquidity, earnings, asset valuation, and progress in pursuing restructuring and divestiture. Federal Reserve staff is also assisted by qualified advisers in its monitoring and coordinates with officials of the Treasury. We routinely make our views known on key issues, such as major incidents of corporate spending and executive compensation. For example, we pressed for the company to ensure that robust corporate governance surrounds all compensation actions and worked with AIG management on limits to executive compensation that restrict salary and bonuses for 2008 and 2009. The Treasury has also imposed standards governing executive compensation that are broader than the general restrictions under the TARP Capital Purchase Program. The Treasury has also required a comprehensive written policy on corporate expenses that may be materially amended only with the Treasury's prior consent. Following the establishment of the Revolving Credit Facility, AIG accessed its funds to meet various liquidity needs and by October 1, 2008, the company had drawn down approximately $61 billion. In part these draws were used to settle transactions with counterparties returning securities they had borrowed from AIG entities under a securities lending program used by AIG insurance subsidiaries. The cash collateral received by AIG in these lending programs was used to purchase a portfolio of residential mortgage-backed securities (RMBS). As the value of RMBS declined, these transactions became a significant source of liquidity strain on AIG. When securities borrowing counterparties chose to terminate their securities borrowing transactions with AIG, AIG was unable to immediately dispose of the illiquid and price-depressed RMBS as a source of repayment to securities borrowers without realizing substantial losses. As a result, AIG had to supply cash from its own resources to repay the securities borrowing counterparties. To reduce these liquidity pressures, the Board approved an additional credit facility (the Secured Borrowing Facility) that permitted the New York Reserve Bank to lend to certain AIG domestic insurance subsidiaries up to $37.8 billion in order to allow them to return the cash collateral they received from their securities borrowing counterparties. The Secured Borrowing Facility was designed to provide the company additional time to arrange and complete the orderly sales of RMBS and other assets in a manner that would minimize losses to AIG and disruption to the financial markets. AIG borrowed approximately $20 billion under the Securities Borrowing Facility by November of 2008. State insurance authorities of AIG's regulated insurance subsidiaries participating in the securities lending program supported the Board's action. Additionally, toward the end of October, four AIG affiliates began participating in the Federal Reserve's Commercial Paper Funding Facility (CPFF) on the same terms and conditions as other participants. The CPFF is a generally available program that involves the purchase, through a special purpose vehicle with financing from the Federal Reserve, of 3-month unsecured and asset-backed commercial paper directly from eligible issuers. As of February 18, 2009, the AIG-affiliated CPFF participants had borrowed approximately $14 billion in the aggregate from the facility. During the month of October, credit markets continued to be severely stressed and liquidity pressures on AIG did not abate even with access to government credit. The company was negatively affected by the decline in market value of many assets owned by AIG entities or to which AIG entities were exposed through derivatives. Losses on the RMBS portfolios in the securities borrowing program and credit default swap protection Financial Products had written on multi-sector CDOs together accounted for approximately $19 billion of the $24.5 billion in losses announced by the company for the third quarter of 2008. The losses experienced through the third quarter, and the consequent capital erosion placed in jeopardy the credit ratings of AIG. Had the credit ratings agencies downgraded AIG in November, AIG would have been required to find additional funds to meet collateral calls and termination events on the exposures held by Financial Products alone. The Board and Treasury therefore took a series of actions, announced on November 10, 2008, to mitigate the effect of third quarter losses and liquidity drains on AIG and its subsidiaries, and provide for a more stable capital structure. These actions were designed to facilitate AIG's execution of its divestiture plan in an orderly manner, and thereby protect the interests of the taxpayers, both by preserving financial stability and by giving AIG more time to repay the Federal Reserve and return the Treasury's investment. As part of the set of actions, Treasury invested $40 billion in newly issued Senior Preferred Stock of AIG under its recently granted TARP authority. In connection with that investment, the Federal Reserve modified the terms of the Revolving Credit Facility to be more sustainable: The maturity of loans extended under the facility was extended to 5 years (due 2013), the maximum amount available was reduced from $85 billion to $60 billion, and the interest rate and commitment fees were reduced. The facility remained secured by substantially all of AIG's assets, and the company continued to be required to apply proceeds of asset sales to permanently repay any outstanding balances under the facility. At the same time, the Board approved the establishment of an additional lending facility that would provide a permanent solution to the AIG securities lending program's losses and liquidity drains, thus eliminating the need for the Securities Borrowing Facility. Under the new facility, the New York Reserve Bank extended approximately $19.5 billion in secured, non-recourse credit to a special purpose limited liability company in which AIG would hold a $1 billion first-loss position (Maiden Lane II). Maiden Lane II then purchased, at market prices, RMBS with a par value of $39.3 billion from certain AIG domestic insurance company subsidiaries. This facility allowed AIG to terminate its securities lending program and to repay fully all outstanding amounts under the Securities Borrowing Facility, which was then terminated. The Federal Reserve also took steps to help address the drain of liquidity on AIG arising from potential collateral calls associated with credit default swap contracts written by Financial Products on multi-sector CDOs. The New York Reserve Bank made a secured, non-recourse loan in the amount of $24.3 billion to another special purpose limited liability company (Maiden Lane III). Maiden Lane III then purchased, at market prices, multi-sector collateralized debt obligations with a par value of approximately $62 billion from credit default swap counterparties of Financial Products in return for the agreement of the counterparties to terminate the credit default swaps. AIG provided $5 billion in equity to Maiden Lane III to absorb future losses on the CDOs held by Maiden Lane III. The Federal Reserve loans to Maiden Lane II and III have a term of 6 years and are secured by the entire portfolio of each company. The Federal Reserve reports the amount of the loans to these facilities and the value of the supporting collateral regularly on its Web site. The investment manager to the New York Reserve Bank for these entities projects that, even under very stressed scenarios, the loans to Maiden Lane II and Maiden Lane III will be repaid over time with no loss to the taxpayer. On Monday, March 2, 2009, AIG announced a loss of approximately $62 billion for the fourth quarter of 2008, ending a year in which AIG suffered approximately $99 billion in total net losses. As a consequence of increased economic weakness and market disruption, the insurance subsidiaries of AIG, like many other insurance companies, have recorded significant losses on investments in the fourth quarter of 2008. Commercial mortgage-backed securities and commercial mortgages have experienced especially severe impairment in market value, requiring a steep markdown on the companies' books, despite a lack of significant credit losses on these assets to date. The loss of value in the company's investment portfolios, which totaled approximately $18.6 billion pre-tax, was primarily attributable to the insurance subsidiaries' holdings. This loss was a substantial contributor to AIG's fourth quarter loss. The remainder of the fourth quarter loss was significantly associated with the mark to market of assets transferred to Maiden Lane II and Maiden Lane III during the middle of that quarter, losses due to accounting on securities lending transactions that occurred during the fourth quarter, impairment of deferred tax assets and goodwill, and other market valuation losses. At the same time, general economic weaknesses, along with a tendency of the public to pull away from a company that it viewed as having an uncertain future, hurt AIG's ability to generate new business during the last half of 2008 and caused a noticeable increase in policy surrenders. In addition, these extreme financial and economic conditions have greatly complicated the plans for divestiture of significant parts of the company in order to repay the U.S. Government for its previous support. Would-be buyers themselves are experiencing financial strains and lack access to financing that would make such purchases possible. To address these weaknesses, the Federal Reserve and Treasury, in consultation with management of AIG and outside advisers retained by the Federal Reserve, announced on March 2, 2009, a plan designed to provide longer-term stability to AIG while at the same time facilitating divestiture of its assets and maximizing likelihood of repayment to the U.S. Government. The plan involves restructuring the current obligations of AIG to the Federal Reserve and Treasury, additional capital contributions by Treasury, and continued access to Federal Reserve credit on a limited basis for ongoing liquidity needs of AIG. Under the plan, Treasury will create a new capital facility that would allow AIG to issue to the Treasury up to $30 billion over 5 years in new preferred shares under the TARP as liquidity and capital needs arise. This brings the total equity support of the Treasury to $70 billion. Additionally, Treasury will restructure the $40 billion in preferred equity AIG issued to the Treasury in connection with the actions taken to aid the company in November. This restructuring, along with the injections of capital from the new preferred shares, will bolster AIG's capital position and reduce its leverage, bolstering confidence in the company. Under the plan, the Federal Reserve also has agreed to reduce and restructure AIG's outstanding debt under the Revolving Credit Facility. Capacity under the Revolving Credit Facility will be reduced from $60 billion to $25 billion. The current outstanding debt of $39.5 billion will be restructured in several ways. First, up to about $26 billion will be satisfied by providing the Federal Reserve with preferred equity interests in AIG's two largest life insurance subsidiaries, American Life Insurance Company (ALICO) and American International Assurance Company (AIA). The actual amount will be a percentage of the fair market value of AIA and ALICO based on valuations acceptable to the Federal Reserve. This action would be a positive step toward preparing these two valuable AIG subsidiaries for sale to third parties or disposition through an initial public offering, the proceeds of which would return to the Federal Reserve through its preferred equity interest stake in these two companies. Another component of the debt restructuring involves the use of an insurance industry tool to monetize cash flows on a specified block of life insurance policies already in existence. Under the plan, the Federal Reserve would extend up to $8.5 billion in credit to special purpose vehicles (SPV) that would repay the obligation from the net cash flows of identified blocks of life insurance policies previously issued by certain AIG domestic life insurance subsidiaries. The total amount of principal and interest due to the Federal Reserve on this credit would represent a fixed percentage of the estimated net cash flow from the underlying policies that would flow to the borrowing SPVs. This ``buffer'' between the amount of the credit and the net cash flow would provide the Federal Reserve with security and provide reasonable assurance of repayment. Each of the decisions to provide assistance to AIG has been difficult and uncomfortable for us. However, the Federal Reserve and the Treasury agree that the risks and potential costs to consumers, municipalities, small businesses and others who depend on AIG for insurance protection in their lives, operations, pensions, and investments, as well as the risks to the wider economy, of not providing this assistance during the current economic environment are unacceptably large. The disorderly failure of systemically important financial institutions during this period of severe economic stress would only deepen the current economic recession. We have been and will continue to work alongside the Treasury and other Government agencies to avoid this outcome. At the same time, in exercising the tools at our disposal, we are also committed to acting only when and to the extent that our assistance is necessary and can be effective in addressing systemic risks and we are committed to protecting the interests of the U.S. Government and taxpayer. ______ CHRG-111hhrg48873--42 Mr. Bachus," Thank you. Secretary Geithner, on September 14th, you and Secretary Paulson met with AIG to discuss Lehman's failure and their worsening condition? " FOMC20070321meeting--177 175,VICE CHAIRMAN GEITHNER.," Do we have any precedent, Vince, for reference to financial conditions described as favorable or otherwise? We’ve said that it’s supported by accommodative policy." fcic_final_report_full--490 III. THE U.S. GOVERNMENT ’S ROLE IN FOSTERING THE GROWTH OF THE NTM MARKET The preceding section of this dissenting statement described the damage that was done to the financial system by the unprecedented number of defaults and delinquencies that occurred among the 27 million NTMs that were present there in 2008. Given the damage they caused, the most important question about the financial crisis is why so many low quality mortgages were created. Another way to state this question is to ask why mortgage standards declined so substantially before and during the 1997-2007 bubble, allowing so many NTMs to be created. This massive and unprecedented change in underwriting standards had to have a cause—some factor that was present during the 1990s and thereafter that was not present in any earlier period. Part III addresses this fundamental question. The conventional explanation for the financial crisis is the one given by Fed Chairman Bernanke in the same speech at Morehouse College quoted at the outset of Part II: Saving inflows from abroad can be beneficial if the country that receives those inflows invests them well. Unfortunately, that was not always the case in the United States and some other countries. Financial institutions reacted to the surplus of available funds by competing aggressively for borrowers, and, in the years leading up to the crisis, credit to both households and businesses became relatively cheap and easy to obtain . One important consequence was a housing boom in the United States, a boom that was fueled in large part by a rapid expansion of mortgage lending. Unfortunately, much of this lending was poorly done, involving, for example, little or no down payment by the borrower or insuffi cient consideration by the lender of the borrower’s ability to make the monthly payments . Lenders may have become careless because they, like many people at the time, expected that house prices would continue to rise--thereby allowing borrowers to build up equity in their homes--and that credit would remain easily available, so that borrowers would be able to refinance if necessary. Regulators did not do enough to prevent poor lending, in part because many of the worst loans were made by firms subject to little or no federal regulation. [Emphasis supplied] 59 In other words, the liquidity in the world financial market caused U.S. banks to compete for borrowers by lowering their underwriting standards for mortgages and other loans. Lenders became careless. Regulators failed. Unregulated originators made bad loans. One has to ask: is it plausible that banks would compete for borrowers by lowering their mortgage standards? Mortgage originators—whether S&Ls, commercial banks, mortgage banks or unregulated brokers—have been competing for 100 years. That competition involved offering the lowest rates and the most benefits to potential borrowers. It did not, however, generally result in 59 Speech at Morehead College April 14, 2009. 485 or involve the weakening of underwriting standards. Those standards—what made up the traditional U.S. mortgage—were generally 15 or 30 year amortizing loans to homebuyers who could provide a downpayment of at least 10-to-20 percent and had good credit records, jobs and steady incomes. Because of its inherent quality, this loan was known as a prime mortgage. CHRG-111hhrg58044--320 Mr. Pratt," Chairman Gutierrez, Ranking Member Hensarling, and members of the subcommittee, thank you for this opportunity to testify. I will highlight just a few points in my oral remarks. First, preserving a full and complete credit history is imperative. A central pillar of the credit reporting system is that it is full-file. And this means the database contains both positive and negative information about a consumer's management of his or her debts. The FCRA balances this fundamental idea that all accurate and predictive data is available for risk management, with the requirement that data that is considered adverse be deleted, generally, within 7 years. Congress recognized that a system that allows for the accumulation of payment history spanning decades is inherently fair for consumers. Because there is a positive payment history, any adverse data resulting from hardship or even mismanagement is set into this context. Credit reports are the bridge of data for us, as consumers, in an impersonal marketplace. Credit reports tell our story, a story of hard work, good values, and even times of trial. Credit reports are the basis for building fair and unbiased risk management tools, such as credit scores. Credit scores remove the risk of bias and mere opinion. Race and gender, for example, are no longer barriers to accessing loans and other services. It is for these reasons that we remain very concerned with H.R. 3149's proposal that the 7-year period for reporting paid medical debts reported by collection agencies be changed to a 30-day period. Consider the following: Maintaining stability of the system of data is essential. We all understand, better than ever, the importance of safe and sound underwriting. Removing accurate predictive data is not the right step. It's not the right direction. Some may misunderstand the nature of the 7-year period. It does not begin on the date of the final payment or settlement. This seven-year period is running throughout the period of time that the account is on the file prior to payment. Data is regularly evaluated for predictive qualities. Prematurely removing even a paid debt which was delinquent removes even the possibility of considering how these data help ensure fair and also safe and sound decisions. We support the FCRA's current approach to adverse data. We urge the committee to consult with users of data about the consequences of deleting any data, since it isn't merely an issue for the consumer reporting agency, but ultimately it's an issue for users who manage risk. Let me now turn to the uses of credit reports for employment. While credit scores are not provided by our members for employment purposes, credit reports are used, and this permissible purpose should be maintained. H.R. 3149 proposes to place a significant limitation on the use of credit reports. We understand the desire to ensure consumers are getting jobs they need during this period of high unemployment. But it is our view that credit histories do not serve as an impediment. Following are some important points to consider: First, employers' use of any criterion for employment is highly regulated. Employers must determine whether or not the use of a credit history is appropriate for a given position. The FCRA, in fact, requires the employer to certify that it will not use data in violation of any applicable Federal or State equal employment opportunity law or regulation. The Society for Human Resources Management surveyed its members. They found, for example, that their members use credit checks for positions that have fiduciary or financial responsibilities, for executive positions, CFOs, or for positions where employees have access to a customer's assets, corporate secrets, and technology platforms, including access to sensitive personal information. And I think these uses make sense. While media counts might lead readers to think differently, background screening products only include a credit check in about 15 percent of the cases. In other words, 85 percent of the time, a credit report is not used in the employment decision. The Association of Certified Fraud Examiners, however, has reviewed occupational fraud, and it found two top red flags exhibited by perpetrators of fraud were: living beyond one's means; and experiencing financial difficulties. Finally, there seems to be a view that credit checks serve as a final yes or no for an employer. This is not the case. Employers use applications, testing, interviews, resume data, and many other data points. The credit check is used where it makes sense. Preserving this appropriate use under the current law is the right policy outcome. Thank you for this opportunity to testify, and we look forward to your questions. [The prepared statement of Mr. Pratt can be found on page 115 of the appendix.] " CHRG-111hhrg51698--177 Mr. Walz," Thank you, Mr. Chairman, and to our Ranking Member for holding this, as my colleagues have said, incredibly informative discussion. I do want to thank each and every one of you. You are being very candid, very open; and that is very helpful to us. Because, the bottom line is that we all want our markets to function correctly. We want to make sure that they are regulated to the point where people have trust in them, but that we are still encouraging innovation and people to move forward on some of these instruments. So all of us are trying to understand this. I think in that spirit, because this is very complicated--and I do thank Chairman Peterson personally. He has for several years talked to me and tried to educate me on these. What I would like to do, maybe Mr. Buis or Mr. Gooch, if you would help me, if each one of you would tell me--Mr. Buis, you can pick that soybean farmer out in Albert Lea, Minnesota, that is a Farmers Union member. Tell me how the future market works for them and how it affects their paycheck. Then, Mr. Gooch, tell me what your brokers do and what the futures market does and how they collect their paycheck, and what role each of them has in securing the economic well-being of this country. If you could do that, that would really help. Because I want to talk to my constituents about why this affects them. It is all too easy to demonize or take a populist position and point fingers. I want to get it right. So, Tom, if you want to start. " CHRG-111shrg57320--347 Mr. Doerr," It is circular. We need access to determine the condition of the institution and they are saying we have no disagreements. The institution is sound, and so you have no basis. " CHRG-109hhrg31539--200 Mr. Bernanke," Well, again, as I mentioned before, if financial conditions are such that aggregate demand is greater than the underlying productive capacity of the economy-- " CHRG-110hhrg46594--54 Mr. Kanjorski," You have to--accounting-wise, you have to be--if everybody acted against your best interest, there is a time you cannot meet your condition--somebody has briefed you on that, Mr. Wagoner. " CHRG-111hhrg58044--175 Chairman Gutierrez," The time of the gentleman has expired. The gentlelady from New York is recognized for 5 minutes. Mrs. McCarthy of New York. Thank you, Mr. Chairman. I thank you for having this hearing. I thank the panelists for their information. We know that some individuals do not have traditional credit reports. Some have alternative reports that are created by items such as rental payments and utilities, to create a credit history. Those kinds of reports typically are different than a traditional credit report in underwriting. For all of you, the current economic downturn has resulted in financial struggles for many of our constituents. As a result, they have seen their credit reports negatively impacted, even though they have had a good history from the past. How could this affect an individual's ability to renew their insurance? I will throw that out to all of you. " FOMC20061212meeting--201 199,MS. DANKER.," I’ll be reading the directive and risk assessment from page 23 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” Then: “Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”" FOMC20081216meeting--307 305,MR. LOCKHART.," Thank you, Mr. Chairman. My preference is to move in this meeting to the consensus lower-bound range for the funds target, and I prefer the range of 0 to 25. So I believe either alternative A or alternative B will work as serviceable options, and I can live with either one. But I actually lean toward alternative B. I think it is the clearest, and with the inclusion of the language related to deflation, it is also internally more consistent. In particular, my preference is to indicate that the FOMC intends to keep the policy rate low until economic and credit conditions improve, and I think it is appropriate to emphasize that our policies will be calibrated based on longer-term inflation objectives. As I said yesterday, I am thinking that the conditionality language could be stronger. Specifically, I have in mind something along the lines of a statement that reads that ""the Committee intends to maintain this range for the federal funds rate until such time that it judges conditions are present for material and sustained improvements in financial market functioning and economic growth, and the Committee believes that this policy course is consistent with its medium-term price stability objective."" I think that kind of language could fit at the beginning of paragraph 4, around that area, in alternative B. I think that is stronger than the implicit conditionality that is already in the statement. In my rounds of contacts before the meeting, one conversation did resonate with me. It was a call from a financial market participant for hearing what the plan is and what the strategy is and affirming that there is a plan. I think stronger conditionality language would respond to that need in the marketplace. As regards the questions, I think I have already covered some of them. I would prefer the specifying of a range in alternative B. I would lean toward including the language ""and sees some risk that inflation could decline"" because it ties in with the ""all available tools"" language at the beginning of paragraph 4. In other words, I think, if we include that language in paragraph 3, we are setting up a risk and the ""employ all available tools"" responds strongly to that risk. Regarding the inclusion of the long-term Treasury securities, I am persuaded by Governor Kohn's comment that we should include it. It is consistent with whatever public discussion we have had to date, including your speech of two weeks ago. So that is all. Thank you, Mr. Chairman. " CHRG-110shrg50416--126 Chairman Dodd," I appreciate that, and that is not easy and so we thank you. We want you to keep us--we will be working with you as well, and if you have these kinds of concerns, we ought to stay in close touch, the Committee staff and others, with you. Let me, if I can, Ms. Duke, let me ask you, we talked about all the other Federal entities that own a significant number of mortgages that are receiving resources and backing. In the financial rescue legislation that Congress passed, we require each of your agencies to actually work to modify mortgages here. Governor Duke, the Fed owns a significant number of these mortgages, many of which are subprime and delinquent as a result of the $30 billion of the assets that the Fed acquired from Bear Stearns back in March. And yet I notice that you do not mention those mortgages in your testimony. What specific steps has the Fed undertaken to conduct mortgage workouts of those loans that the Fed acquired as a result of the Bear Stearns issue? And how many of the loan modifications or workouts have been done? Ms. Duke. Mr. Chairman, I am going to have to confess I do not know about the assets that are in that $30 billion portfolio. It is my understanding that they are pledged as collateral and that they would be actually mortgage-backed security assets. If I could respond to you in writing? " FOMC20081216meeting--240 238,CHAIRMAN BERNANKE.," Why don't we reconvene, have a brief summary of our goround, and then I will make just a few additional comments. The participants noted that the economic downturn has intensified sharply recently with significant downside risks to the outlook. Recessionary dynamics have set in, with interplays among real and financial variables. The economy is likely to contract through early next year, with considerable uncertainty about subsequent developments. Consumption, employment, and production indicators have weakened further. Financial conditions remain very strained, with improvement in some areas, but many the same or worse. The global economy has also slowed markedly. Looking more specifically at different sectors, credit conditions continue to tighten, with credit lines not being renewed and banks, including smaller banks, hunkering down. Securitization markets are still largely dysfunctional. The overall deleveraging process continues to be a powerful drag on activity. Delinquencies are increasing, implying greater credit losses for banks and other lenders, with small businesses being among the borrowers facing tighter conditions. Banks continue to face intense balance sheet pressures and are reluctant to lend or make markets, and feedback effects from worsening credit quality to the balance sheets of financial institutions are evident. Regarding the consumer, spending continues to contract, as households face ongoing pressures with respect to wealth, income, credit availability, and job security. Psychology is very negative, and luxury and discretionary expenditures are being cut back. Labor market developments have been negative as well, with accelerating job losses and participation finally declining after remaining high for a period of time. The latest housing numbers suggest a continued contraction in that sector. The fall in mortgage rates has sparked some refinancing and purchase mortgage applications, but the longer-term impact on housing demand is not yet evident. Nonresidential construction is projected to fall significantly, reflecting poor fundamentals and tight credit. Federal fiscal policy will likely provide aid to states, including funds for infrastructure, but the size and the timing of the economic impact of that policy remain uncertain. Manufacturing production continues to slow, along with new orders, capital spending, and business expectations; mining and drilling activities have been reacting to the decline in commodity prices, as has agricultural activity to some extent. Export demand has weakened with the sharp slowing in the global economy of recent months and the strengthening of the dollar since the summer. The sharp global slowdown, including emerging markets, will make recovery more difficult. Manufacturing surveys show that firms expect considerable near-term weakness and declining pricing power. Finally, inflation looks set to decline significantly, reflecting falling commodity prices, rising slack, limited pricing power, and falling inflation expectations. Participants cited the risk that inflation could fall below desired levels. That is just a very quick summary. Any comments? Let me make just a few additional comments, but I won't add, I think, a great deal of insight to our discussion. I will just note for the record here that the NBER has finally recognized that a recession began in December 2007. I said in the Christmas tree lighting ceremony that they also recognized that Christmas was on December 25 last year. [Laughter] The Committee was a little more forward-thinking. We began cutting rates, of course, in September 2007 and did 100 basis points of cuts in January 2008. Despite our efforts, this recession, in terms of duration and depth, is likely to be equal to or greater than the two largest previous postwar recessions, those in 1974-75 and 1981-82. There are a number of reasons that may be the case, and some of them were already discussed by the staff. The financial conditions are the most obvious difference between this recession and the earlier ones. A number of previous recessions have had financial headwinds of one type or another. For example, the current financial crisis and housing correction bear some family relationship to the stock market decline and the capital overhang in the 2001 recession. But overall, the financial aspects of this episode are, I think, much more serious than in previous cases. To cite two aspects: One, as Governor Warsh noted, there has been a big impact on household wealth. The flow of funds accounts show a decline in nominal wealth of about 11 percent in the last year or, as he said, a decline in real wealth of about 15 percent. This is going to lead to an increase in saving, which would be desirable in the longer term but in the short term is going to create dislocation. Two, this financial crisis has affected the intermediation of credit far more severely than any other episode since the 1930s. We have already seen a big impact on intermediary capital and bank activity. The deleveraging process is continuing. It is very intense. Again, reduced risk-taking, deleveraging, all of those things are not necessarily bad, but the adjustment process is a very difficult one. A second reason that this recession could well be more severe than the previous ones has to do with the cyclical position of monetary policy, a fact also noted by the staff. The 1974-75 and 1981-82 recessions were basically generated by a tightening of monetary policy, and when the Federal Reserve decided to let up, essentially conditions began to rebound. Obviously, in this case, other factors have driven the downturn. Monetary policy was proactive in trying to promote recovery. But given where we are today, at the zero lower bound, we are unable to ease policy in the way that we saw in those previous episodes. This suggests, as others have noted, the need for additional policy actions, either on our part or by the fiscal authorities, to get the economy moving again. Finally, a third reason that I think this episode is particularly severe is the global nature of the downturn, which a number of people have also noted. It has always been said that, if the United States sneezes, the rest of the world catches cold. So there has always been a certain amount of coherence or synchronicity between U.S. downturns and those around the world. But the extent of the global downturn this time is really quite exceptional. It is striking that global growth over the past few years has been between 4 and 5 percent, and now the Greenbook is looking at a 1.6 percent decline for global activity in the fourth quarter and a decline of about 0.6 percent in the first quarter. That is quite a big difference between what we might think of as potential and actual growth. So, as I said, there are a number of reasons to think that this is going to be a very severe episode and that we are far from being at the turning point. I won't go through the sectors. We have all discussed consumption, employment, housing, commercial real estate, and financial markets. These are all aspects of the downturn that continue to be exceptional and very worrisome as we look forward. I will make just a couple of comments about inflation or disinflation. The forecast is for significant disinflation--perhaps not deflation, although deflation is easily within the standard errors of the forecast. A number of factors may affect this forecast or create risks on both sides. Stephanie talked about structural unemployment perhaps being a factor that might make the effect of slack less than otherwise. On the other hand, there may be some evidence that the Phillips curve is steeper when unemployment is high--that is, recessions tend to have a greater impact on inflation than do small changes in growth. That only goes to say that there is a lot of uncertainty about exactly how far the inflation rate will fall. Although we might reach a technical deflation, I guess it is worth pointing out here that there is nothing special about zero. That is, from this point on, any further disinflation will have the effects of making a given nominal interest rate a higher real interest rate. It is making monetary policy de facto tighter and perhaps having debt deflation effects as the real value of debts and debt payments becomes greater as inflation falls. Because we are already at the zero lower bound, obviously that constraint is already in play. So I think we shouldn't focus too much or focus the public too much on the deflation line, on that zero number. It is not all that consequential. Rather, the disinflation process--and a very low rate of inflation--is a source of concern. Just to summarize, I don't think my outlook differs very significantly from what I have heard around the table. I think the issues are what we do about it, and in that spirit, we should turn now to the policy round. So let me turn to Brian to introduce the monetary policy alternatives. " FOMC20071211meeting--98 96,MS. PIANALTO.," Thank you, Mr. Chairman. The conversations that I have had with my business contacts indicate that business conditions in our region have clearly softened since the last meeting and perhaps even more than what is reflected in the Beige Book report that we prepared just a few weeks ago. A sense of pessimism about the economic outlook seems once again to be sweeping over our business community, and it is not just the financial community. This is a decided change from what I was hearing in October and is clearly an added threat to our already fragile outlook. My banking supervision staff reports that the District banks continue to address the risks in their portfolios by shifting focus away from residential and commercial real estate and by requiring more collateral, stronger covenants, and better debt-service coverage in their deals. But our examiners are not reporting that capital positions of our financial institutions have been impaired such that they cannot accommodate sound projects. A few of the corporate CFOs I talk with say that credit commitments are more difficult to come by. The CEOs of the Fourth District financial institutions advise me that what we are facing is a liquidity squeeze and not at present a credit crunch. That said, these bank CEOs have expressed concern that their capital positions could become impaired if the current pressure for more liquidity forces them to sell some of their assets at large discounts. The incoming data for the economy appear to be unfolding reasonably close to my October projection. I was fairly pessimistic about our near-term growth prospects, and that pessimism seems to have been well founded. So the economic data by themselves haven’t been enough to push me off the forecast trajectory that I submitted at our last meeting. But as I noted earlier, I do observe a sharp drop in business confidence across a broad collection of industries, not just those tied to residential real estate. What I am hearing sounds more substantial than the transitory slowing that I was projecting just six weeks ago. What I am hearing from my business contacts is probably more aligned with the prolonged slow growth outlook that I now see in the Greenbook baseline, or worse. I am somewhat thankful that I didn’t have to submit a projection for this meeting because I am torn between what my mostly data-driven model says and what I am hearing from my business sources. About the only thing that I can say with much confidence is that the reemergence of liquidity pressures, combined with the deterioration in business confidence, has increased the downside risk to growth. I think it is prudent to address that risk with our policy decision today, but I will hold my comments about our policy moves for later in the meeting. Thank you, Mr. Chairman." CHRG-110hhrg46595--514 The Chairman," Well, take that--I remember when the press office said you can only do that as a Chapter 11. That is true if you are a lawyer arguing in court. You are now before the body that wrote Chapter 11 and it can rewrite Chapter 11. And there is a problem that lawyers have, which is to assume in the normal course of a legal argument you are restricted to choose between column A and column B. We can write column C third. So the answer is, it would not necessarily be that we mandated people to do things, you can come up with constitutional issues with that. But the old doctrine of unconstitutional conditions on gifts seems to me have long since disappeared into the mists. And if we are going to vote all that money, we can put on it any conditions that we think appropriate, so we are not restricted to either Chapter 11 or not. We can write what we think is appropriate with these powers. The gentleman from California. " fcic_final_report_full--458 Given the likelihood that large numbers of subprime and Alt-A mortgages would default once the housing bubble began to deflate in mid- 2007—with devastating effects for the U.S. economy and financial system—the key question for the FCIC was to determine why, beginning in the early 1990s, mortgage underwriting standards began to deteriorate so significantly that it was possible to create 27 million subprime and Alt-A mortgages. The Commission never made a serious study of this question, although understanding why and how this happened must be viewed as one of the central questions of the financial crisis. From the beginning, the Commission’s investigation was limited to validating the standard narrative about the financial crisis—that it was caused by deregulation or lack of regulation, weak risk management, predatory lending, unregulated derivatives and greed on Wall Street. Other hypotheses were either never considered or were treated only superficially. In criticizing the Commission, this statement is not intended to criticize the staff, which worked diligently and effectively under diffi cult circumstances, and did extraordinarily fine work in the limited areas they were directed to cover. The Commission’s failures were failures of management. 1. Government Policies Resulted in an Unprecedented Number of Risky Mortgages Three specific government programs were primarily responsible for the growth of subprime and Alt-A mortgages in the U.S. economy between 1992 and 2008, and for the decline in mortgage underwriting standards that ensued. The GSEs’ Affordable Housing Mission. The fact that high risk mortgages formed almost half of all U.S. mortgages by the middle of 2007 was not a chance event, nor did it just happen that banks and other mortgage originators decided on their own to offer easy credit terms to potential homebuyers beginning in the 1990s. In 1992, Congress enacted Title XIII of the Housing and Community Development Act of 1992 6 ( the GSE Act), legislation intended to give low and 6 Public Law 102-550, 106 Stat. 3672, H.R. 5334, enacted October 28, 1992. 453 moderate income 7 borrowers better access to mortgage credit through Fannie Mae and Freddie Mac. This effort, probably stimulated by a desire to increase home ownership, ultimately became a set of regulations that required Fannie and Freddie to reduce the mortgage underwriting standards they used when acquiring loans from originators. As the Senate Committee report said at the time, “The purpose of [the affordable housing] goals is to facilitate the development in both Fannie Mae and Freddie Mac of an ongoing business effort that will be fully integrated in their products, cultures and day-to-day operations to service the mortgage finance needs of low-and-moderate-income persons, racial minorities and inner-city residents.” 8 The GSE Act, and its subsequent enforcement by HUD, set in motion a series of changes in the structure of the mortgage market in the U.S. and more particularly the gradual degrading of traditional mortgage underwriting standards. Accordingly, in this dissenting statement, I will refer to the subprime and Alt-A mortgages that were acquired because of the affordable housing AH goals, as well as other subprime and Alt-A mortgages, as non-traditional mortgages, or NTMs FOMC20071211meeting--120 118,CHAIRMAN BERNANKE.," But I think I’m in the camp of those who see a fundamental softening going on here. One indicator is the pattern of final demand. This zigzag pattern has been mostly in a situation with basically about 2 percent growth in final demand but with quarter-to- quarter variation in exports and inventories. We see in this case the opposite. Growth in private domestic final demand is projected by the Greenbook to fall to minus 0.2 percent in the fourth quarter and another minus 0.3 percent in the first quarter of next year. It does seem to have been a step-down in economic growth outside of housing. The other issue is the financial markets, which so many people have commented on. I just note that there are several elements to this. First are the losses and the downgrades that have hit capital. These have been only partially offset by new capital issuances. In particular, we’ve seen about $75 billion in write-downs or losses in the financial sector, of which $45 billion has occurred since our last meeting, at a time when we thought things were clearing up. Criticized loans by our supervisors for the top fifty bank holding companies rose from 26 to 28 percent over the last quarter. So we’re seeing continued losses, and I expect to see that to go forward. The second element of this is the pressure on balance sheets. Banks are taking off-balance-sheet assets onto the balance sheet. An example that Governor Kroszner mentioned is the leveraged-loan market, which was open for a while and now seems to be closed, and securitization markets remain closed. Moreover, and I think this is particularly worrisome going forward, supervisors—and you all, of course, talk to your supervisors—are increasingly concerned about credit quality as it looks likely to evolve. Commercial real estate is one area in which we’ve seen essentially no defaults yet, but these things tend to lag, and there’s a lot of expectation both among bankers and among supervisors of that sector weakening. One indicator of banks’ views is that they have been raising their loan-loss provisions at a rapid rate, $17 billion in the third quarter. It was at a twenty-year high, and we are certainly hearing from, for example, the Federal Advisory Council that they expect credit quality to continue to deteriorate. The result of this is that, although I do not expect insolvency or near insolvency among major financial institutions, they are certainly going to become much more cautious, and I think that will affect their lending behavior and their willingness to extend new credit. As has been pointed out, some of the natural substitutes like the so-called shadow banking system are not really there at this point, and I would also be less sanguine than some about regional and community banks, which face their own problems: lack of securitization outlets and a lot of exposure to commercial real estate. So I do think that we’re going to see some tightening of credit and that it could get worse. Experience suggests that, while financial conditions are always different and the financial structure has changed significantly, credit crunches can have a big effect on the economy. The case that’s been cited the most is the 1991-92 crunch, when the capital losses were pretty limited regionally but, nevertheless, there was a national impact. Another smaller, perhaps less relevant, example is the Carter credit controls in March 1980, which were very small in their aspiration yet somehow managed to create a short recession. So I believe that the financial conditions are going to be a significant drag. It is going to go on for a while. Given the low growth expectations, it could lead us into a negative growth area. I see realistically only one way in which we could avoid a drag from the financial system, which would be if, in fact, we get lucky and the housing market begins to stabilize and there’s a sense that we’ve reached bottom there and house prices are stabilizing. I think that would do a tremendous amount of good for the financial system. It might lead to sufficient improvement as to avoid some of these consequences. You know, I do think that we have to take note of the fact that the two-year government yield is down about 75 basis points in real terms since our last meeting and that five-year bond yields are down about 60 basis points in real terms. That’s certainly a market view on what’s happening to growth expectations, and it’s not terribly inconsistent with some of the figures that come out of the Greenbook calculations. So obviously there are mixed views, but I think it is very hard to argue that both the modal growth forecast and the rest of that output forecast have not shifted adversely. With respect to inflation—again, people made these points as well—it is unfortunate that we do have some instability, some risks there. We saw some stabilization of the dollar over the past six weeks. That is obviously not exogenous. It depends on our behavior and our communication. I think oil prices depend also to some extent on our policy, directly or indirectly. We will be seeing some ugly near-term inflation numbers with oil price increases, which we hope will move out of the data shortly, but we’re not sure. So obviously we have to watch that. I think there are a few things that are slightly helpful on that front. One is that, relative to the previous intermeeting period, there’s more conviction now that other countries may be easing monetary policy. In fact, we’ve seen cuts in Canada and the United Kingdom. I think that takes a bit of the risk away from the dollar. I do not know how big the impact of the national intelligence estimate about Iran will be, but it certainly reduces a bit the geopolitical risk that has been around oil over the past couple of years. But, of course, I agree with Governor Mishkin and many others that, whatever we might be tempted to do in terms of trying to get ahead of the financial conditions and what I fully believe will be ultimately a Main Street problem as well as a Wall Street problem, we need to be highly cognizant—this is not a ritual but an honest statement—of those implications for inflation expectations and the dollar as well. So let me stop there, just adding that I think the situation is very difficult and we need to recognize the uncertainty that we’re facing. I believe that in response we will have to make sure that we are sufficiently flexible, open minded, willing to accept new evidence and new information, and willing to respond actively and quickly when we do get that new information. Let me stop there, and let me now ask for volunteers—oh, sorry—before we do that, Brian will introduce the policy go-round." CHRG-111shrg50814--21 Chairman Dodd," I should have mentioned in prefacing my question, I am, at least for my part, anyway, grateful to the administration for stepping up on the housing issue, the $75 billion that has been committed in the mitigation on foreclosures. I wish we had done that a year ago. It might have made the situation less dramatic than it is today, but I welcome that move, as well. With that, let me turn to Senator Shelby, and look at that, right on the money here, so 5 minutes. Senator Shelby. I will try to do the same, Mr. Chairman. Thank you. Adequacy of bank capital, I would like to get into that. Mr. Chairman, regulators from each part of the banking industry, including the Federal Reserve, have testified multiple times before the Banking Committee in the past few years that the banking industry was healthy and strong, yet we are now discussing taking very drastic measures to recapitalize the very same system. A lot of people wonder, where were the regulators in the past 5 or 6 years, including the Federal Reserve. For example, in 2004, before the Banking Committee, FDIC Chairman Powell said, and I quote, ``I am pleased to report''--that is to the Banking Committee--``that the FDIC insured institutions are as healthy and sound as they have ever been.'' Additionally, in 2004, OTS Director James Gilleran stated before the Banking Committee, and I quote, ``It is my pleasure to report on a thrift industry that is strong and growing in asset size. While we continue to maintain a watchful eye on interest rate risk in the thrift industry, profitability, asset quality, and other key measures of financial health are at or near record levels.'' Also before this committee in 2004, Comptroller of the Currency John Hawke testified, ``National banks continue to display strong earnings, improving credit quality following the recent recession and sound capital positions.'' He even said that banks have adopted better risk management techniques. In 2005, your predecessor of the Fed, Chairman Alan Greenspan, said before the Banking Committee here, ``Nationwide banking and widespread securitization of mortgages make financial intermediation less likely to be impaired than it was in some previous episodes of lethal house price correction.'' In fact, as recently as 2008, Chairman of the FDIC Bair testified and said, and I quote, ``The vast majority of institutions remain well capitalized, which will help them withstand the difficult challenges in 2008 while broader economic conditions improve.'' Comptroller Dugan, Comptroller of the Currency, said here before the Banking Committee in 2008, and I will quote, ``Despite these strains, the banking system remains fundamentally sound, in part because it entered this period of stress in a much stronger condition.'' Finally, in 2008, Federal Reserve Vice Chairman Kohn testified before this Committee, and I quote, ``The U.S. banking system is facing some challenges, but it remains in sound overall condition, having entered the period of recent financial turmoil with solid capital and strong earnings. The problems in the mortgage and housing markets have been highly unusual and clearly some banking organizations have failed to manage their exposures well and have suffered losses as a result. But in general, these losses should not threaten their viability.'' Chairman Bernanke, are your capital measures and amounts of capital adequate? You are regulator of the largest banks. What does the present state of the banking industry tell us about our capital regime, and what does it mean if banks are adequately capitalized, yet somehow we need to spend billions, if not trillions, of dollars to stabilize the system? " CHRG-111shrg54589--140 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM GARY GENSLERQ.1.a. Do you believe the existence of an actively traded cash market is or should be a necessary condition for the creation of a derivative under law and regulation?A.1.a. Answer not received by time of publication.Q.1.b. If not, what specific, objective means besides a cash basis market could or should be used as the underlying relationship for a derivative?A.1.b. Answer not received by time of publication.Q.2. Why should the models to price OTC derivatives not be published? If there is no visible cash basis for a derivative, and the model is effectively the basis, why should the models not be public?A.2. Answer not received by time of publication.Q.3. What is the best way to draw the line between legitimate hedges and purely speculative bets? For example, should we require an insurable interest for purchasers of credit protection, require delivery of the reference asset, or something else?A.3. Answer not received by time of publication.Q.4. Is the concern that increased regulation of derivatives contracts in the United States will just move the business overseas a real issue? It seems to me that regulating the contracts written in the U.S. and allowing American firms to only buy or sell such regulated contracts would solve the problem. What else would need to be done?A.4. Answer not received by time of publication.Q.5. Should parties to derivative contracts be required to post cash collateral, or is other collateral acceptable? And is there any reason not to require segregation of customer collateral?A.5. Answer not received by time of publication.Q.6. Is there any reason standardized derivatives should not be traded on an exchange?A.6. Answer not received by time of publication.Q.7. It seems that credit default swaps could be used to manipulate stock prices. In a simple example, an investor could short a stock, and then purchase credit default swaps on the company. If the swaps are not heavily traded, the purchase would likely drive up the price of the swaps, indicating higher risk of default by the company, and lead to a decline in the stock price. Is there any evidence that such manipulation has taken place? And more generally, what about other types of manipulation using derivatives?A.7. Answer not received by time of publication.Q.8. Credit default swaps look a lot like insurance when there are unbalanced, opportunistic sellers. However, life and property insurance requires an insurable interest for the buyer and reserves for the seller. Why should we not regulate these swaps like traditional insurance?A.8. Answer not received by time of publication.Q.9. How do we take away the incentive for credit default swap holders to force debtors into bankruptcy to trigger a credit event rather than renegotiate the debt?A.9. Answer not received by time of publication.Q.10. How do we reduce the disincentive for creditors to perform strong credit research when they can just buy credit protection instead?A.10. Answer not received by time of publication.Q.11. In her testimony Chairman Schapiro mentioned synthetic exposure. Why is synthetic exposure through derivatives a good idea? Isn't that just another form of leverage?A.11. Answer not received by time of publication.Q.12. Regarding synthetic exposure, if there is greater demand for an asset than there are available assets, why shouldn't the economic benefit of that demand--higher value--flow to the creators or owners of that asset instead of allowing a dealer to create and profit from a synthetic version of that asset?A.12. Answer not received by time of publication.Q.13. One of the arguments for credit default swaps is that they are more liquid than the reference asset. That may well be true, but if there is greater demand for exposure to the asset than there is supply, and synthetic exposure was not allowed, why wouldn't that demand lead to a greater supply and thus more liquidity?A.13. Answer not received by time of publication.Q.14. Is there any justification for allowing more credit protection to be sold on a reference asset than the value of the asset?A.14. Answer not received by time of publication.Q.15. Besides the level of regulation and trading on an exchange, there seems to be little difference in swaps and futures. What is the need for both? In other words, what can swaps do that forward contracts cannot?A.15. Answer not received by time of publication.Q.16. One of the arguments for keeping over-the-counter derivatives is the need for customization. What are specific examples of terms that need to be customized because there are no adequate substitutes in the standardized market? Also, what are the actual increased costs of buying those standard contracts?A.16. Answer not received by time of publication.Q.17. On the second panel, Mr. Whalen suggests that Congress should subject all derivatives to the Commodity Exchange Act, at least as an interim step. Is there any reason we should not do so?A.17. Answer not received by time of publication.Q.18. There seems to be agreement that all derivatives trades need to be reported to someone. Who should the trades be reported to, and what information should be reported? And is there any information that should not be made available to the public?A.18. Answer not received by time of publication.Q.19. Is there anything else you would like to say for the record?A.19. Answer not received by time of publication. ------ CHRG-110shrg50420--220 Mr. Nardelli," No, sir. Senator Shelby. But the last time Congress bailed out an automaker--as I said, it was in 1979--that legislation conditioned Government assistance to Chrysler providing a restructuring plan that met very specific requirements, including minimum concessions from its creditors, suppliers, workers, and dealers. A lot of us do not believe your plan comes up close to providing the same level of detail. How does your restructuring plan that you provided to the Committee compare with the financial reports you provide to prospective investors? Is it the same or is it different? And if it is different, why is it different? " CHRG-111hhrg67816--153 Mr. Leibowitz," Credit source, are you talking about credit source? Yes, they are included in the free credit report. " FOMC20070918meeting--223 221,MS. JOHNSON.," In conjunction with the establishment of the ACF, the staff proposes that the FOMC authorize temporary reciprocal currency arrangements with the European Central Bank and the Swiss National Bank. These facilities would provide dollar financing for parallel credit auctions for euro area and Swiss banks, which the staff understands would be conducted in a manner broadly similar to that provided for U.S. banks by the ACF, which Sandy just described. The proposal is for swap arrangements that would authorize the ECB and the SNB to draw up to $10 billion and $5 billion, respectively, each week with individual draws for a period of twenty-eight days. Cumulative totals may reach $40 billion for the ECB and $20 billion for the SNB. The swap arrangements would expire after six months unless renewed. The purchases of U.S. dollars with foreign currency would be based on the prevailing spot exchange rate, and the ECB and the SNB would charge their banks and pay interest on the swap at the rate established each week by the U.S. auction. These temporary swap arrangements are proposed so that dollar funding problems now faced by European banks, particularly at terms longer than overnight, can be addressed in a parallel manner and at the same time that dollar funding problems of U.S. banks are addressed. Improved conditions in European dollar trading would guard against the spillover of volatility in such trading to New York trading and could help reduce term funding pressures in U.S. markets. Establishment of these swap lines in parallel with the ACF could have broad, positive confidence effects. Given the financial positions of these two central banks, the swap lines would involve virtually no credit risk on our part. By providing dollars to the ECB and the SNB to use in their efforts to address the term dollar funding problems in Europe, we benefit the credit markets without ourselves providing support to banks overseas." FOMC20070509meeting--186 184,MS. DANKER.," I’ll be reading the directive and the risk assessment from page 23 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” The risk assessment: “In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”" FOMC20050322meeting--230 228,MR. BERNANKE.," Thank you, Mr. Chairman. I support the recommendation. I think the addition of the phrase “appropriate policy action” is actually useful, because it will emphasize that our forecast is conditional on continued tightening rather than being an unconditional forecast. I agree with Governor Kohn and Governor Ferguson, among others, that it’s important to provide as much information as we have about future developments in the economy and policy. And I think perhaps we should consider the alternative C language that Vincent Reinhart has suggested. Finally, I would just like to raise the issue of process. Of course, it’s very useful to get March 22, 2005 98 of 116 reflect the discussion at the meeting and the condition of the economy. Therefore, it needs to be understood that we have some flexibility to make changes nearer to the meeting. I think that’s an important point to recognize. Thank you." FOMC20081007confcall--55 53,MR. ROSENGREN.," Economic and financial conditions have deteriorated significantly. I strongly support a 50 basis point reduction, and I would not change the language. Thank you, Mr. Chairman. " FOMC20071031meeting--54 52,MS. PIANALTO.," Thank you, Mr. Chairman. Like many others around the table, my report to this Committee in September indicated a sharp deterioration in business confidence. My business contacts were concerned about what may happen. During the intermeeting period I heard less about what may happen and more about what is actually happening. My contacts who are linked to residential real estate have seen a further and, in some cases, sharp drop-off in business activity. My banking supervision and regulation staff told me just a few days ago that they’re now seeing a sudden and sizable percentage increase in nonperforming loans at a number of large banking companies in my District. To be sure, nonperforming loans had been at extremely low levels, and most of the sharp rise can be traced to mortgage and construction development lending. But I’m now beginning to hear reports that bankers are experiencing some loan performance problems outside their real estate portfolio. The CEO of a large, major bank in my District has also reported difficulty in securitizing the student loans that they’re making, forcing them to keep those loans on their books and to make adjustments elsewhere in their balance sheets. To what extent these banking conditions are affecting overall bank lending is not obvious, but clearly there has been some disruption to the channels of intermediation, and I am now beginning to hear reports of some spillover to other sectors of the economy. A growing number of retailers tell me that they have seen a noticeable decline in spending since mid-September in items ranging from autos to apparel. While my reports from the business community reflect a falloff in business conditions from what we submitted to the Beige Book just a few weeks ago, they don’t necessarily indicate a significant deviation from the slowdown that was already built into the economic projections that I submitted in September. In preparing for this meeting, I found it difficult to judge whether the reports of weakness that I am hearing represent an unfolding of the September projection or additional deterioration in the outlook. In the end, I have only minor differences with the Greenbook projection in the near term and, like the Greenbook, made only minor revisions to my forecast. I see economic activity a bit softer than the Greenbook for the remainder of 2007, but I project slightly better growth in 2008. Like the Greenbook, I have assumed an unchanged path for the fed funds rate over the forecast period. The recent rise in oil prices has caused me to push up my near-term PCE projection, but inflation expectation projections remain anchored around 2 percent. I see a small upside risk to the near-term inflation projection as a result of the continuing dollar depreciation; but on the whole, I continue to judge our inflation risks as reasonably balanced. I would like to conclude by echoing the sentiments of others around the table. Considerable strains in the financial sector remain, and further turmoil in markets is a distinct possibility. I think that, in this environment, households and businesses can easily be spooked—excuse the Halloween pun—and I don’t think it would take much additional tightness in credit markets to push my fragile near-term growth outlook even lower. So this concern continues to be the predominant risk to my outlook. Thank you, Mr. Chairman." CHRG-110shrg50420--466 PREPARED STATEMENT OF SENATOR DANIEL K. AKAKA Mr. Chairman, thank you for conducting this hearing today. I am greatly concerned about the potential consequences of the collapse of the domestic automobile industry. With more than 730,000 workers employed in the automotive vehicle and parts industries, the financial condition of Chrysler, Ford, and General Motors is significant to our economy. These automakers are tied to suppliers, dealers, bondholders, and many others whose welfare is directly linked to their solvency. An auto industry collapse would be devastating, particularly during the current recession. However, we must make sure that the assistance is coupled with business practice changes that ensure the near and long term vitality of these companies. I look forward to continuing to work with you and the other Members of this Committee to bring about enactment of legislation that will help stabilize the financial condition of our domestic automakers. Thank you, Mr. Chairman. CHRG-111shrg52619--177 PREPARED STATEMENT OF GEORGE REYNOLDS Chairman, National Association of State Credit Union Supervisors, and Senior Deputy Commissioner, Georgia Department of Banking and Finance March 19, 2009NASCUS History and Purpose Good morning, Chairman Dodd, and distinguished Members of the Senate Committee on Banking, Housing, and Urban Affairs. I am George Reynolds, Senior Deputy Commissioner of Georgia Department of Banking and Finance and chairman of the National Association of State Credit Union Supervisors (NASCUS). \1\ I appear today on behalf of NASCUS, the professional association of state credit union regulators.--------------------------------------------------------------------------- \1\ NASCUS is the professional association of the 47 state credit union regulatory agencies that charter and supervise the nation's 3,300 state-chartered credit unions.--------------------------------------------------------------------------- The mission of NASCUS is to enhance state credit union supervision and advocate for a safe and sound state credit union system. We achieve our mission by serving as an advocate for the dual chartering system, a system that recognizes the traditional and essential role of state governments in the national system of depository financial institutions. Thank you for holding this important hearing today to explore modernizing financial institution supervision and regulation. The regulatory structure in this country has been a topic of discussion for many years. The debate began when our country's founders held healthy dialogue about how to protect the power of the states. More recently, commissions have been created to study the issue and several administrations have devoted further time to examine the financial regulatory system. Most would agree that if the regulatory system were created by design, the current system may not have been deliberately engineered; however, one cannot overlook the benefits offered by the current system. It has provided innovation, competition and diversity to our nation's financial institutions and consumers. In light of our country's economic distress, many suggest that regulatory reform efforts should focus, in part, on improving the structure of the regulatory framework. However, I suggest that it is not the structure of our regulatory system that has failed our country, but rather the functionality and accountability within the regulatory system. A financial regulatory system, regardless of its structure, must delineate clear lines of responsibility and provide the necessary authority to take action. Accountability and transparency must also be inherent in our financial system. This system must meet these requirements while remaining sufficiently competitive and responsive to the evolving financial service needs of American consumers and our economy. Credit union members and the American taxpayer are demanding each of these qualities be present in the nation's business operations and they must be present in a modernized financial regulatory system. These regulatory principles must exist in a revised regulatory system. This is accomplished by an active system of federalism, a system in which the power to govern is shared between national and state governments allowing for clear communication and coordination between state and federal regulators. Further, this system provides checks and balances and the necessary accountability for a strong regulatory system. I detail more about this system in my comments.NASCUS Priorities for Regulatory Restructuring NASCUS' priorities for regulatory restructuring focus on reforms that strengthen the state system of credit union supervision and enhance the capabilities of state-chartered credit unions. The ultimate goal is to meet the financial needs of consumer members while assuring that the state system is operating in a safe and sound manner. This provides consumer confidence and contributes to a sound national and global financial system. In this testimony, I discuss the following philosophies that we believe Congress must address in developing a revised financial regulatory system. These philosophies are vital to the future growth and safety and soundness of state-chartered credit unions. Preserve Charter Choice and Dual Chartering Preserve States' Role in Financial Regulation Modernize the Capital System for Credit Unions Maintain Strong Consumer Protections, which often Originate at the State Level My comments today will focus solely on the credit union regulatory system; I will highlight successful aspects and areas Congress should carefully consider for refinement.Preserving Charter Choice and Dual Chartering The goal of prudential regulation is to ensure safety and soundness of depositors' funds, creating both consumer confidence and stability within the financial regulatory system. Today's regulatory system is structured so that states and the federal government act independently to charter and supervise financial institutions. The dual chartering system for financial institutions has successfully functioned for more than 140 years, since the National Bank Act was passed in 1863, allowing the option of chartering banks nationally. It is important that Congress continue to recognize the distinct roles played by state and federal regulatory agencies. Dual chartering remains viable in the financial marketplace because of the distinct benefits provided by charter choice and due to the interaction between state and federal regulatory agencies. This structure works effectively and creates the confidence and stability needed for the national credit union system.Importance of Dual Chartering The first credit union in the United States was chartered in New Hampshire in 1909. State chartering remained the sole means for establishing credit unions for the next 25 years, until Congress passed the Federal Credit Union Act (FCUA) in 1934. Dual chartering allows an institution to select its primary regulator. For credit unions, it is either the state agency that regulates state-chartered credit unions in a particular state or the National Credit Union Administration (NCUA) that regulates federal credit unions. Forty-seven states have laws that permit state-chartered credit unions, as does the U.S. territory of Puerto Rico. Any modernized regulatory restructuring must recognize charter choice. The fact that laws differ for governing state and federal credit unions is positive for credit unions and consumers. A key feature of the dual chartering system is that individual institutions can select the charter that will benefit their members or consumers the most. Credit union boards of directors and CEOs have the ability to examine the advantages of each charter and determine which charter matches the goals of the institution and its members. Congress intended state and federal credit union regulators to work closely together, as delineated in the FCUA. Section 201 of the FCUA states, `` . . . examinations conducted by State regulatory agencies shall be utilized by the Board for such purposes to the maximum extent feasible.'' \2\ NCUA accepts examinations conducted by state regulatory agencies, demonstrating the symbiotic relationship between state and federal regulators.--------------------------------------------------------------------------- \2\ 12 U.S. Code 1781(b)(1).--------------------------------------------------------------------------- Congress must continue to recognize and to affirm the distinct roles played by state and federal regulatory agencies. The U.S. regulatory structure must enable state credit union regulators to retain regulatory authority over state-chartered credit unions. This system is tried and it has worked for the state credit union system for 100 years. It has been successful because dual chartering for credit unions provides a system of ``consultation and cooperation'' between state and federal regulators. \3\ This system creates the appropriate balance of power between state and federal credit union regulators.--------------------------------------------------------------------------- \3\ The Consultation and Cooperation With State Credit Union Supervisors provision contained in The Federal Credit Union Act, 12 U.S. Code 1757a(e) and 12 U.S. Code 1790d(l).--------------------------------------------------------------------------- A recent example of state and federal credit union examiners working together and sharing information is the bimonthly teleconferences held since October of 2008 to discuss liquidity in the credit union system. Further, state regulators and the NCUA meet in-person several times a year to discuss national policy issues. The intent of Congress was that these regulators share information and work together and in practice, we do work together. Another exclusive aspect of the credit union system is that both state and federal credit unions have access to the National Credit Union Share Insurance Fund (NCUSIF). Federally insured credit unions capitalize this fund by depositing one percent of their shares into the fund. This concept is unique to credit unions and it minimizes taxpayer exposure. Any modernized regulatory system should recognize the NCUSIF. The deposit insurance system has been funded by the credit union industry and has worked well for credit unions. We believe that credit unions should have access to this separate and distinct deposit insurance fund. A separate federal regulator for credit unions has also worked well and effectively since the FCUA was passed in 1934. NASCUS and others are concerned about any proposal to consolidate regulators and state and federal credit union charters. Charter choice also creates healthy competition and provides an incentive for regulators (both state and federal) to maximize efficiency in their examinations and reduce costs. It allows regulators to take innovative approaches to regulation while maintaining high standards for safety and soundness. The dual chartering system is threatened by the preemption of state laws and the push for a more uniform regulatory system. As new challenges arise, it is critical that the benefits of each charter are recognized. As Congress discusses regulatory modernization, it is important that new policies do not squelch the innovation and enhanced regulatory structure provided by the dual chartering system. As I stated previously, dual chartering benefits consumers, provides enhanced regulation and allows for innovation in our nation's credit unions. Ideally, the best of each charter should be recognized and enhanced to allow competition in the marketplace. NASCUS believes dual chartering is an essential component to the balance of power and authority in the regulatory structure. The strength and health of the credit union system, both state and federal, rely on the preservation of the principles of the dual chartering system.Strengths of the State System State-chartered credit unions make many contributions to the economic vitality of consumers in individual states. Our current regulatory system benefits citizens and provides consumer confidence. To begin, one of the strengths of the state system is that states operate as the ``laboratories'' of financial innovation. Many consumer protection programs were designed by state legislators and state regulators to recognize choice and innovation. The successes of state programs have been recognized at the federal level, when like programs are introduced to benefit consumers at the federal level. It is crucial that state legislatures maintain the primary authority to enact consumer protection statutes for residents in their states and to promulgate and enforce state consumer protection regulations, without the threat of federal preemption. We caution Congress about putting too much power in the hands of the federal regulatory structure. Dual chartering allows power to be distributed throughout the system and it provides a system of checks and balances between state and federal authorities. A system where the primary regulatory authority is given to the federal government may not provide what is in the best interest of consumers.Preserve States' Role in Financial Regulation The dual chartering system is predicated on the rights of states to authorize varying powers for their credit unions. NASCUS supports state authority to empower credit unions to engage in activities under state-specific rules, deemed beneficial in a particular state. States should continue to have the authority to create and to maintain appropriate credit union powers in any new regulatory reform structure debated by Congress. However, we are cognizant that our state systems are continuously challenged by modernization, globalization and new technologies. We believe that any regulatory structure considered by Congress should not limit state regulatory authority and innovation. Preemption of state laws and the push for more uniform regulatory systems will negatively impact our nation's financial services industry, and ultimately consumers. Congress should ensure that states have the authority to supervise state credit unions and that supervision is tailored to the size, scope and complexity of the credit union and the risk they may pose to their members. Further, Congress should reaffirm state legislatures' role as the primary authority to enact consumer protection statutes in their states. Added consumer protections at the state level can better serve and better protect the consumer and provide greater influence on public policy than they can at the federal level. This has proved true with data security and mortgage lending laws, to name a few. It is crucial that states maintain authority to pursue enforcement actions for state-chartered credit unions. Congress' regulatory restructuring efforts should expand the states' high standards of consumer protection. Recently, Chairman Barney Frank (D, Mass.) of the House Financial Services Committee, said, ``States do a better job,'' when referring to consumer protection. NASCUS firmly believes this, too.Comprehensive Capital Reform for Credit Unions The third principle I want to highlight is modernizing the capital system for credit unions. Congress should recognize capital reform as part of regulatory modernization. Capital sustains the viability of financial institutions. It is necessary for their survival. NASCUS has long supported comprehensive capital reform for credit unions. Credit unions need access to supplemental credit union capital and risk-based capital requirements; these related but distinctly different concepts are not mutually exclusive. The current economic environment necessitates that now is the time for capital reform for credit unions.Access to Supplemental Capital State credit union regulators are committed to protecting credit union safety and soundness. Allowing credit unions access to supplemental capital would protect the safety and soundness of the credit union system and provide a tool to use if a credit union faces declining net worth or liquidity needs. A simple fix to the FCUA would authorize state and federal regulators the discretion, when appropriate, to allow credit unions to use supplemental capital. NASCUS follows several guiding principles in our quest for supplemental capital for credit unions. First, a capital instrument must preserve the not-for-profit, mutual, member-owned and cooperative structure of credit unions. Next, it must preserve credit unions' tax-exempt status. \4\ Finally, regulatory approval would be required before a credit union could access supplemental capital. We realize that supplemental capital will not be allowed for every credit union, nor would every credit union need access to supplemental capital.--------------------------------------------------------------------------- \4\ State-chartered credit unions are exempt from federal income taxes under Section 501(c)(14) of the Internal Revenue Code, which requires that (a) credit union cannot access capital stock; (b) they are organized/operated for mutual purposes; and without profit. The NASCUS white paper, ``Alternative Capital for Credit Unions . . . Why Not?'' addresses Section 501(c)(14).--------------------------------------------------------------------------- Access to supplemental capital will enhance the safety and soundness of credit unions and provide further stability in this unpredictable market. Further, supplemental capital will provide an additional layer of protection to the NCUSIF thereby maintaining credit unions' independence from the federal government and taxpayers. Allowing credit unions access to supplemental capital with regulatory approval and oversight will enhance their ability to react to market conditions, grow safely into the future, serve their nearly 87 million members and provide further stability for the credit union system. We feel strongly that now is the time to permit this important change. Unlike other financial institutions, credit union access to capital is limited to reserves and retained earnings from net income. Since net income is not easily increased in a fast-changing environment, state regulators recommend additional capital-raising capabilities for credit unions. Access to supplemental capital will enable credit unions to respond proactively to changing market conditions, enhancing their future viability and strengthening their safety and soundness. Supplemental capital is not new to the credit union system; several models are already in use. Low-income credit unions are authorized to raise uninsured secondary capital. Corporate credit unions have access, too; they have both membership capital shares and permanent capital accounts, known as paid-in capital. These models work and could be adjusted for natural-person credit unions.Risk-Based Capital for Credit Unions Today, every insured depository institution, with the exception of credit unions, uses risk-based capital requirements to build and to monitor capital levels. Risk-based capital requirements enable financial institutions to better measure capital adequacy and to avoid excessive risk on their balance sheets. A risk-based capital system acknowledges the diversity and complexity between financial institutions. It requires increased capital levels for financial institutions that choose to maintain a more complex balance sheet, while reducing the burden of capital requirements for institutions holding assets with lower levels or risk. This system recognizes that a one-size-fits-all capital system does not work. The financial community continues to refine risk-based capital measures as a logical and an important part of evaluating and quantifying capital adequacy. Credit unions are the only insured depository institutions not allowed to use risk-based capital measures as presented in the Basel Accord of 1988 in determining required levels or regulatory capital. A risk-based capital regime would require credit unions to more effectively monitor risks in their balance sheets. It makes sense that credit unions should have access to risk-based capital; it is a practical and necessary step in addressing capital reform for credit unions.Systemic Risk Regulation The Committee asked for comment regarding the need for systemic risk regulation. Certainly, the evolution of the financial services industry and the expansion of risk outside of the more regulated depository financial institutions into the secondary market, investment banks and hedge funds reflect that further consideration needs to be given to having expanded systemic risk supervision. Many suggest that the Federal Reserve System due to its structural role in the financial services industry might be well suited to be assigned an expanded role in this area.The Role of Proper Risk Management During this period of economic disruption, Congress should consider regulatory restructuring and also areas where risk management procedures might need to be strengthened or revised to enhance systemic, concentration and credit risk in the financial services industry. Congress needs to address the reliance on credit rating agencies and credit enhancement features in the securitization of mortgage-backed securities in the secondary market. These features were used to enhance the marketability of securities backed by subprime mortgages. Reliance on more comprehensive structural analysis of such securities and expanded stress testing would have provided more accurate and transparent information to market analysts and investors. Further, there is a debate occurring about the impact of ``mark-to-market'' accounting on the financial services industry as the secondary market for certain investment products has been adversely impacted by market forces. While this area deserves further consideration, we urge Congress to approach this issue carefully in order to maintain appropriate transparency and loss recognition in the financial services industry. Finally, consideration needs to be given to compensation practices that occurred in the financial services industry, particularly in the secondary market for mortgage-backed securities. Georgia requires depository financial institutions that are in Denovo status or subject to supervisory actions that use bonus features in their management compensation structure not to simply pay bonuses based on production or sales, but also to include an asset quality component. Such a feature will ``claw back'' bonuses if production or sales result in excessive volumes of problematic or nonperforming assets. If such a feature were used in the compensation structure for the marketing of asset-backed securities, perhaps this would have been a deterrent to the excessive risk taking that occurred in this industry and resulted in greater market discipline.Conclusion Modernizing our financial regulatory system is a continuous process, one that will need to be fine-tuned over time. It will take careful study and foresight to ensure a safe and sound regulatory structure that allows enhanced products and services while ensuring consumer protections. NASCUS recognizes this is not an easy process. To protect state-chartered credit unions in a modernized regulatory system, we encourage Congress to consider the following points: Enhancing consumer choice provides a stronger financial regulatory system; therefore charter choice and dual chartering must be preserved. Preserve states' role in financial regulation. Modernize the capital system for credit unions to protect safety and soundness. Maintain strong consumer protections, which often originate at the state level. It is important that Congress take the needed time to scrutinize proposed financial regulatory systems. NASCUS appreciates the opportunity to testify today and share our priorities for a modernized credit union regulatory framework. We urge this Committee to be watchful of federal preemption and to remember the importance of dual chartering and charter choice in regulatory modernization. We welcome questions from Committee Members. Thank you. FOMC20061025meeting--246 244,MS. DANKER.," I’ll be reading the directive wording and the risk assessment for alternative B from page 29 of the Bluebook: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” Then the risk assessment: “Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”" FOMC20070321meeting--235 233,MS. DANKER.," Okay. Let me start with the directive on page 28 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” Now the amended assessment of risk: “In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”" FOMC20070321meeting--14 12,VICE CHAIRMAN GEITHNER.," You made a distinction at the beginning between something that was fundamental and something that was about a change in risk perception. Just conceptually, how do you distinguish between those two things? Is the latter something that you can’t attribute to a change in observable economic conditions?" CHRG-111hhrg51592--141 Mr. Volokh," Got it. So if somebody wants to go out there and convey their opinion and have other people pay for the opinion, they are free to do so, but if they want a special government imprimatur that allows an issuer of bonds to include that opinion as part of its issue, they have to comply with certain things. I tried to speak to that in some measure in my remarks, and I think that, generally speaking, that would be constitutionally permissible if, going forward, the government were to say, as a condition of getting this particular special government benefit, we demand that you comply with certain kinds of accounting procedures or that you not take any money from the organization that you are rating, or even that you agree to be liable under a negligence standard, then I think as a condition-- " FOMC20080916meeting--54 52,CHAIRMAN BERNANKE., All right. So this is all conditional on agreements and discussions with other counterparties. We will come up with a joint communication announcement strategy. President Plosser. FOMC20071031meeting--265 263,CHAIRMAN BERNANKE.," Yes, let’s do that because it will be more consistent with the statement. So let me ask everyone to rethink their risks conditional on our policy move today." FOMC20070321meeting--189 187,CHAIRMAN BERNANKE.," Okay. I get a general sense of agreement around the table, unless someone wants to speak strongly in favor of financial conditions. President Stern." CHRG-111shrg54589--149 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM ROBERT G. PICKELQ.1.a. Do you believe the existence of an actively traded cash market is or should be a necessary condition for the creation of a derivative under law and regulation?A.1.a. In general, derivatives markets tend to be more liquid than underlying cash markets. For example, bank loans and many bonds issues tend to be fairly illiquid. There is no good reason to prohibit credit default swaps on such securities because the underlying instruments do not trade in a liquid market. Such a prohibition would only serve to reduce bank lending capacity and the ability and willingness of investors to purchase bonds, which would not be desirable while the economy is in the midst of a credit crunch. Privately negotiated derivatives are built on the fundamental principle of freedom of contract. Two parties can construct a mutually beneficial agreement to address their risk management needs, which may or may not be related to the existence of a cash market. We question whether the creation of such an agreement should be subject to conditions specified by law or regulation, especially since regulators can use powers they already have to limit trading in products that are judged to threaten systemic stability.Q.1.b. If not, what specific objective means besides a cash basis market could or should be used as the underlying relationship for a derivative?A.1.b. We do not believe it would be productive to attempt to legislate or regulate the types of risks traded in derivatives markets. All derivatives reference risks arising from normal economic activity are borne by market participants. Most securities, even the most basic types of securities such as bonds, embody a bundle of risks. The benefit of derivatives is that they permit the unbundling and pricing of specific risks. For example, an investor holding a corporate bond bears both interest rate risk and credit risk. Those individual risks can separately be traded, and valued, using interest rate derivatives and credit default swaps. By allowing investors to unbundle and trade individual risks, derivatives make it possible for investors to tailor the risks they bear. Likewise, hedgers in commercial markets can reduce financial risk while concentrating on managing the business risk associated with their enterprises. The need to manage specific risks can change as economic conditions change. Any a priori restriction on the types of risks that can be referenced by derivatives could easily hamper effective risk management.Q.2. Why should the models to price OTC derivatives not be published? If there is no visible cash basis for a derivative and the model is effectively the basis, why should the models not be public?A.2. As a general matter, prices are determined through trading and not by financial models. Financial models attempt to explain the factors determining values of financial instruments. Many such models lend insight into the factors that influence prices of financial instruments, which is why some traders use financial models to inform their trading decisions. But most existing models cannot predict asset prices accurately enough to be used exclusively for price setting, which is why many more traders do not rely on financial models. In addition to informing trading decisions, models are used for risk management purposes and to value illiquid positions for which market prices are not readily available. Many dealers currently publish newsletters that analyze factors determining the behavior of credit default swap valuation along with insights into how they model the behavior of credit default swap spreads. Moreover, existing regulations require regulated financial intermediaries to disclose to regulators in detail the methods they use to value financial instruments and to measure risk and the controls placed on such processes. This is as it should be. But there has been no demonstrated advantage, yet there would be great expense, associated with a legal mandate requiring every institution to publish the details of their own proprietary models and to explain in detail how they apply those models in practice. We are not suggesting that greater forms of transparency are not desirable. For example, ISDA has recently released the ISDA CDS Standard pricing (originally developed by JPMorgan) as part of an effort to facilitate the central clearing of standardized credit default swap contracts. The ISDA standard CDS model does not determine CDS prices. It merely provides a standardized method for calculating changes in up-front payments for standardized credit default swaps based on changes in credit default swap spreads. Credit default swap spreads are still determined through trading, however, which is the principal method of price discovery in all markets. The ISDA model is freely available to all market participants on a Web site maintained by Markit at www.cdsmodel.com. As a final point, we are not aware of any derivatives market for which there is no cash basis. We are aware that some commentators have leveled this criticism at the credit default swaps market, but we believe the criticism is misplaced. The cash basis for credit default swaps is the difference between the credit default swap spread and observed risk premium paid by bond issuers and borrowers in the loan market. Several good books analyzing and explaining the behavior of the credit default swap basis have been published in recent years. These books are publicly available to all interested parties.Q.3. What is the best way to draw the line between legitimate hedges and purely speculative bets? For example, should we require an insurable interest for purchasers of credit protection, require delivery of the reference asset, or something else?A.3. The dichotomy between ``legitimate'' hedges and ``purely speculative bets'' is a false one because a functioning market requires a seller for every buyer. A person who buys a bond and does not hedge the risk of the bond, for example, could be characterized under an exceedingly narrow definition as engaging in a ``purely speculative bet.'' Few would adopt such a characterization, however, because it would imply that buying bonds without hedging is not legitimate. Similarly, a person who wants to hedge the risk of a bond by buying CDS protection requires that another person be willing to sell protection, which could itself be characterized as a purely speculative bet. Requiring that all hedges be offset by other hedges would result in a ``by appointment only'' market that matches hedges, which would be impossible in the case of credit risk because it is unlikely that a seller of protection would meet the definition of a hedger. Put simply, what is a seller of protection hedging? Further, requiring an insurable interest for purchasers of credit protection, which is meant to apply to insurance products and not to financial derivatives, would effectively make risk transfer impossible. Suppose, for example, that a bondholder buys CDS protection from a bank; the bank that sells protection will normally want to hedge the credit risk it takes on from the bondholder by buying protection. But if only bond owners can buy protection, the bank will not be able to hedge its risk. In the presence of such restrictions, few firms will be willing to act as protection sellers. Finally, requiring delivery of the reference asset, which was the standard means of settlement prior to 2005, would be counterproductive and harmful to bond market liquidity in light of the large number of index CDS transactions found in today's market.Q.4. Is the concern that increased regulation of derivatives contracts in the United States will just move the business overseas a real issue? It seems to me that regulating the contracts written in the U.S. and allowing American firms to only buy or sell such regulated contracts would solve the problem. What else would need to be done?A.4. Derivatives markets are fluid and global. Any increased regulation must take into account that certain trades will not be done or will be done elsewhere. A recent article shows that the concern about business moving overseas is real: According to Euractiv.com, the European Commission's proposed rules for derivative dealers, which appear to be more flexible than those discussed in the U.S., might be intended to ``court'' U.S. dealers faced with a choice of where to conduct business. More broadly, companies need the risk management tools that only derivatives can supply and will respond to arbitrary restrictions on their ability to enter into risk-shifting contracts by seeking out venues where they can enter into such agreements. For example, an American company with foreign subsidiaries routinely needs to enter into a variety of contracts with local parties as part of the conduct of business, and these business dealings will produce risks that they will wish to hedge. The assumption that a U.S. company could always find a market in derivatives for any type of risk in the United States is unfounded. Derivatives contracts are not universal. Interest rate derivatives referencing foreign interest rates, for example, are typically actively traded in the home country of the currency. The demand for such contracts inside the United States might be so limited that a U.S. market for such contracts does not exist. Thus, restricting a U.S. company to trade only U.S.-regulated derivatives will have the effect of prohibiting the hedging of interest rate risks borne by overseas subsidiaries. At the very least, such a prohibition would effectively make it impossible for U.S. banks to offer through overseas subsidiaries a full complement of financial services to U.S. firms operating outside the U.S., which would thereby hamper the competitiveness of any U.S. company with overseas operations.Q.5. Do over-the-counter or custom derivatives have any favorable accounting or tax treatments versus exchange-traded derivatives?A.5. Over-the-counter derivatives may enjoy favorable accounting treatment when they are used to hedge an existing risk. U.S. GAAP hedge accounting guidelines are extremely rigid. Unless a company can demonstrate that a hedge employing a derivative instrument is a nearly perfect hedge, it is required to report the mark-to-market gains and losses from the hedge instrument as a profit or loss, even if it does not report changes in the value of the underlying exposure. By their nature, standardized derivatives contracts almost never qualify as a perfect hedge. Thus, if a company hedges the interest rate risk using interest rate futures it must report any gains or losses on the hedging position in its income statement. But if the underlying instrument is held in the investment portfolio, changes in the market value of the instrument do not affect reported income. Such a regime creates artificial volatility in reported earnings. Similarly, a multinational company that wishes to use standardized foreign exchange futures to hedge against changes in exchange rates might find that the exercise exacerbates the volatility of its reported income. Thus, requiring all companies to use only standardized derivatives may have the unintended effect of making reported income more volatile than it really is. The ultimate result would be to discourage legitimate hedging activity, placing U.S. companies at a competitive disadvantage. Over-the-counter derivatives do not necessarily enjoy favorable tax treatment relative to exchange-traded derivatives. To the extent that the tax treatment may differ, it is because gains and losses on exchange-traded derivatives are recorded daily. Whether this difference benefits the user depends on the nature of the transaction and the ultimate change in the value of the contract, which may be positive or negative. As a general rule, it all depends on the type of transaction, the terms of the contract, and what happens to market prices and rates over the term of the contract.Q.6. In addition to the Administration's proposed changes to gain on sale accounting for derivatives, what other changes need to be made to accounting and tax rules to reflect the actual risks and benefits of derivatives?A.6. ISDA is actively engaged with tax authorities and accounting standard setters on rules governing derivatives. The FASB has an active agenda, and we would encourage policy makers to engage them in consideration of their views. ISDA is concerned about preserving the ability of commercial end users to customize derivatives in order to meet their particular risk management needs. Without the ability to precisely hedge risks in accordance with FASB 133 through customized OTC derivatives, companies would experience increased volatility, reduced liquidity, and higher financing costs.Q.7. Is there any reason standardized derivatives should not be traded on an exchange?A.7. Standardization is a necessary but not sufficient condition for trading on an exchange: Standardized derivatives can be traded on an exchange only when a product has sufficient volume and liquidity to support reliable price discovery for the product. If sufficient volume and liquidity do not exist, it would be preferable to trade the products over-the-counter, that is, execute trades privately, and then manage the risk in other ways, such as through a clearinghouse. Policy discussions frequently confound exchange trading--which means that all trades must be negotiated and executed through a central venue--with clearing--which means that trades must be booked with a central counterparty that serves as the counterparty to all cleared transactions. Exchange trading is possible without clearing, although most exchanges involve clearing as well; and clearing is compatible with both exchange trading and over-the-counter trading. Exchanges and clearinghouses both make use of standardization, but for different reasons. Exchange trading involves extensive standardization because it makes a product easier to trade, which leads to higher liquidity. But as a product becomes more standardized, it may attract a narrower range of traders, leading to lower liquidity. As a result of these conflicting effects, only products that inherently appeal to a large number of traders are likely to succeed on an exchange; more specialized products generally lack liquidity and consequently do not trade successfully on an exchange. Clearinghouses also rely on standardization: not to facilitate trading but to facilitate valuation for the purposes of margin setting. Although cleared products need to be substantially standardized, they need not be as liquid as exchange-traded instruments. What matters is that the clearinghouse can calculate contract values and required margin in a timely manner and can unwind a position in the event of clearing member default.Q.8. How do we take away the incentive for credit default swap holders to force debtors into bankruptcy to trigger a credit event rather than renegotiate the debt?A.8. It is debatable whether such an incentive exists at all. It is more likely that bankruptcy and credit default swap protection are independent of each other. Claims that bought credit default swap protection somehow ``caused'' a bankruptcy filing appear to be based on misunderstanding of how credit default swaps work. One misunderstanding is that buyers of credit default swap protection can profit only if the reference entity actually goes bankrupt. But if the credit quality of a borrower deteriorates, a protection buyer need not wait for bankruptcy, but can instead take its profit by closing out the contract that presumably has appreciated in value. It is even possible that the protection buyer might prefer that the reference entity continue as a going concern instead of fail. Consider an investor that believes that credit default swaps are underpriced relative to the underlying bond. The investor can buy the bond and buy credit protection, thereby locking in a profit. If the reference entity fails, the investor will be compensated and can then seek recovery on the bond. But if the reference entity survives, the investor can continue to collect the difference between the bond's interest and the fee paid for the credit protection. Another misunderstanding is that it is possible to game the bankruptcy system by buying protection on distressed firms and then somehow ``forcing'' the firms into bankruptcy. This misunderstanding appears to be based on the assumption that the cost of protection is independent of the likelihood of a credit event so one can buy protection on distressed firms at a low cost. But the price paid for credit default swap protection is in fact related directly to the expected loss on the reference credit. Indeed, protection on a distressed credit--one widely expected to declare bankruptcy--requires that the protection buyer pay a substantial amount up-front. And if the reference entity does not declare bankruptcy, the protection buyer will in fact incur a substantial loss. A final misunderstanding is that, because a protection buyer is ``made whole'' after a reference entity fails, a protection buyer that cash settles their CDS position and remains in possession of the underlying bond has no incentive to maximize the recovery on the underlying bond. It is not clear why this should be the case: A bond holder that has been compensated and fails to pursue further recovery is in effect ``leaving money on the table,'' which does not seem in the bond holder's interest. The way the credit default swap market works, after settlement of a credit event, someone ends up holding the underlying bond, and that party has an interest in maximizing recovery.Q.9. How do we reduce the disincentive for creditors to perform strong credit research when they can just buy credit protection instead?A.9. The presumption that creditors lack incentives to perform strong credit research belies an understanding of how hedging works. As a general matter, it is necessary to take on risk in order to earn a profit. Because hedging involves giving up risk, it also generally means giving up the potential profit from taking risk, usually by paying the cost of the hedge. Further, routinely entering into hedged transactions is seldom profitable unless one has knowledge superior to that of the rest of the market, which is unlikely to be the case on a systematic basis. Hedging loans with credit default swaps affects profitability as follows. A bank hopes to profit by making a loan; its profit is based on the difference between the bank's cost of funding and the interest charged the borrower. Before making the loan, the bank should perform strong credit research in order to avoid losses from default. But if the bank decides to hedge against losses on the loan by buying credit protection, the bank will have to pay a periodic fee for protection, which will offset some or all of the profit from the loan. A bank that routinely lends and then buys protection on the loans will almost certainly run a loss-making business; the bank has incentive to hedge only if the borrower's condition deteriorates unexpectedly. So the bank can either choose not to hedge and possibly profit, or to hedge but give up the opportunity to profit, but generally cannot both hedge and profit simultaneously.Q.10. Do net sellers of credit protection carry that exposure on their balance sheet as an asset? If not, why shouldn't they?A.10. Because the value of a credit default swap is zero at inception and the parties to the contract do not exchange a consideration at the time the contract is initiated, as typically happens when an asset is purchased or sold, the potential exposure is not recorded on the balance sheet at the time the contract is first settled. Under long-standing accounting conventions, there is no way to record a contract as an asset or liability when no consideration is paid or received and the contract has a zero value. For analogous reasons, banks do not report on their balance sheets the notional amount of loan commitments, stand-by letters of credit and unused amounts on revolving credit lines, which all create a similar type of credit exposure as a credit default swap. This is why such commitments are classified as ``off-balance sheet.'' This is not to say that financial companies are not required to report the amount of their potential credit exposure arising from credit default swaps, however. First, companies must report the mark-to-market value of their derivatives exposures as either a ``derivatives receivable'' or a ``derivatives payable'' when the value of the contract changes. To illustrate, if a bank sells protection on company XYZ and the credit spreads on that company subsequently widen, then the protection seller must record the mark-to-market loss on the contract as a derivatives liability. Similarly, the protection seller's counterparty will record the mark-to-market gain as a derivatives receivable. Second, financial companies are required to report as a supplementary item the notional amount of any financial guarantees they have assumed. Thus, the financial reports of banks and other financial companies contain tables detailing the amount of ``financial guarantees'' the entity has written, including protection sold using credit default swaps, exposures created through written options, and the amount of other financial guarantees that include loan commitments, revolving credit lines and stand-by letters of credit. AIG, for example, did report to investors, credit-rating agencies, and to regulators in its public financial statements that it wrote protection on $125 billion of securities in its 2002 10k. The table below, which draws on data reported in subsequent annual reports, documents the growth in AIG's exposure to $527 billion by year-end 2007, the year when AIG first began reporting losses related to its credit default swap portfolio. ------------------------------------------------------------------------ Amount ($ in Date Reported (at December 31) billions)------------------------------------------------------------------------2002................................................ 125.72003................................................ 203.02004................................................ 290.32005................................................ 387.22006................................................ 483.62007................................................ 527.0------------------------------------------------------------------------ Moreover, AIG's financial reports discuss explicitly the risk the company faced of margin calls stemming from its credit default swap exposure. In short, investors, credit-rating agencies and regulators all had ample prior knowledge of AIG's credit derivatives related potential risk exposure. Like AIG's management, however, all involved parties failed to appreciate the impact a collapsing housing market would have on that exposure. Opaque financial reporting was not the reason why AIG was permitted to amass such a large risk exposure using credit default swaps.Q.11. In her testimony Chairman Schapiro mentioned synthetic exposure. Why is synthetic exposure through derivatives a good idea? Isn't that just another form of leverage?A.11. ``Synthetic exposure'' refers to the ability to take on a risk by means of derivatives or a combination of derivatives and cash instruments. Synthetic exposure is not necessarily equivalent to leverage. For example, many investors use equity swaps to gain synthetic exposure to foreign equities. They do not do this to leverage their exposure. Purchasing foreign equities can be very expensive. In many countries, it can only be done from within the country and ownership is limited to residents. A U.S. investor can enter into an equity swap to gain equivalent economic, or ``synthetic,'' exposure to foreign equities, thereby gaining diversification while holding cash in the form of Treasury bills or other liquid investments. More generally, equity swaps can be used to gain exposure to baskets of equities while avoiding the brokerage fees and other transactions costs associated with buying and selling the cash instruments. Another form of synthetic exposure is exemplified by selling credit default swap protection on asset backed securities. The motivation for doing so is to attain access to investments that are limited in supply, but does not necessarily constitute leverage. This form of synthetic exposure will be discussed in the next question.Q.12. Regarding synthetic exposure, if there is greater demand for an asset than there are available assets, why shouldn't the economic benefit of that demand--higher value--flow to the creators or owners of that asset instead of allowing a dealer to create and profit from a synthetic version of that asset?A.12. Financial assets such as bonds represent a bundle of risks. For a bond, that bundle of risks comprises credit risk, interest rate risk, funding risk, and possibly foreign exchange risk. Derivatives facilitate the unbundling of the different types of risks embodied by securities such as bonds. Because derivatives are not funding transactions, the act of selling protection on a reference entity is not equivalent to buying a bond issued by that entity and does not drain away the benefit of access to credit from the bond issuer. Finance is not a zero-sum game. The benefit that one party derives from being able to trade an unbundled risk does not necessarily diminish the benefit of access to credit by borrowers. In the case of synthetic exposure such as credit default swaps on securitized products, it is doubtful that synthetic exposure occurs at the expense of the ``creators or owners'' of the underlying assets. If access to synthetic exposure is restricted, investors will not necessarily continue to bid up the price of the underlying asset but will likely turn to other, lower priced investments instead. And in many cases, creators or owners of assets will benefit from the existence of synthetic exposure. For instance, a bond issuer may benefit from such activity because it indirectly promotes the liquidity of its bonds, thereby lowering funding costs. Also, after an investor takes on synthetic exposure on an asset by selling protection to a dealer, the dealer will in many cases buy the underlying asset to hedge its own position. The economic benefit in these cases will flow to the owners.Q.13. One of the arguments for credit default swaps is that they are more liquid than the reference asset. That may well be true, but if there is greater demand for exposure to the asset than there is supply, and synthetic exposure was not allowed, why wouldn't that demand lead to a greater supply and thus more liquidity?A.13. Financial assets are not homogeneous--that is, infinitely interchangeable with each other--nor are they completely elastic in supply. Instead, assets are heterogeneous and can generally be issued only in limited amounts. Particularly in the case of fixed income (bond) markets, many individual issues tend to be illiquid. There is therefore demand for access to certain assets that have attractive properties but cannot easily be increased in supply. Restricting access to synthetic exposure would make it more difficult for investors to benefit from exposure to these assets. As noted earlier, financial assets embody a bundle of different risks. Derivatives facilitate the unbundling of risks so that they can be managed individually. Thus, a bond incorporates both interest rate risk and credit risk. What derivatives cannot do is to confer the benefit of funding to the contract's counterparties. Therefore, the act of selling credit protection does not divert the benefit of receiving credit from the borrower. To the contrary, the availability to creditors of a means of hedging and trading the borrower's credit risk in more liquid markets should facilitate the availability of credit, thereby benefiting the bond issuer. In general, market liquidity tends to reduce borrowing costs, which is why interest rates paid by bond issuers tend to be lower than interest rates on loans.Q.14. Is there any justification for allowing more credit protection to be sold on a reference asset than the value of the asset?A.14. For every buyer of protection, there is a seller of protection. Prior to default, the terms of a credit default swap is determined by market sentiment regarding a firm's prospects, but has no causal influence that we are aware of on the underlying bond's price. After default, recent experience has shown that the vast majority of the offsetting bought and sold protection net down to a comparatively small proportion of the market. Harrah's, for example, has $17 billion of outstanding debt compared with $30 billion of outstanding CDS protection. But according to the Depository Trust Clearing Corporation, this $30 billion of CDS protection nets down to $1.86 billion, which is far less than the amount of outstanding debt. Given the ISDA Credit Event Auction Mechanism, most protection buyers need not deliver the underlying asset, so there is little if any liquidity pressure on the underlying asset.Q.15. Besides the level of regulation and trading on an exchange, there seems to be little difference in swaps and futures. What is the need for both? In other words, what can swaps do that forward contracts cannot?A.15. A swap is a bundle of forward contracts with different maturity dates. In the early days of trading in interest rate futures, the exchanges listed contracts with maturities extending only 2 years into the future. Swaps and other OTC derivatives originally were created in part to address the needs of market participants who wished to hedge longer-dated exposures. While market participants currently have a broader choice of standardized contracts, they typically turn to OTC markets for longer-dated contracts and, more generally, when available standardized products do not meet their needs. Only highly standardized contracts can be traded on exchanges because contract standardization facilitates liquidity by limiting trading to just a few contracts. The Eurodollar futures contract, for example, specifies a $1 million notional principal. These contracts are listed for quarterly expiration (in March, June, September, and December) on the second London business day preceding the third Wednesday of the expiration month. Such standardized contracts are well suited for speculation on changes in the general level of interest rates, but are ill-suited to hedge the unique risk exposures borne by most market participants. In the parlance of derivatives markets, using exchange traded derivatives requires hedgers to take on significant basis risk, the risk that changes in the value of the exposure being hedged and changes in the value of the hedging instrument might not fully offset each other. For example, a company may have floating-rate bonds outstanding for which the interest rate resets on the 15th of February, May, August, and November. As noted above, however, the only available interest rate contracts mature in the third week of March, June, September, and December. In such circumstances, the company would find it impossible to hedge perfectly its interest exposure. Each interest payment would be unhedged for over a month of the quarter. Instead of taking on the basis risk, the company could enter into an OTC interest rate swap, thereby effectively passing on the basis risk to an OTC derivatives dealer. OTC dealers have a natural advantage in managing such risks because they trade continuously with a large number of counterparties and have the skilled personnel and order flow necessary to manage interest rate risk arising from mismatched contracts and exposures. For these reasons, futures markets tend to be professional markets while the OTC markets serve the needs of customers such as corporates and smaller, less-sophisticated banks. There is no easy way around this obstacle. The range of listed contracts cannot be extended to include all contracts because most individual contracts arising from commercial trade are so unique as to be inherently illiquid. Simply listing a contract on an exchange does not guarantee liquidity, and may actually reduce the liquidity of existing contracts. Every derivatives exchange has had experience listing new contracts that subsequently had to be withdrawn because the contract never acquired sufficient interest to become viable. If a contract is illiquid, it cannot be marked to market reliably and the exchange clearinghouse cannot manage the associated risk as effectively as with a liquid instrument. Thus, a blanket requirement that all derivatives be exchange traded would have the practical effect of prohibiting most contracts for deferred delivery, including such straightforward transactions as the purchase or sale of fuel oil or wheat at a negotiated price for delivery at a chosen future date. Mandating that all risk management solutions be standard does not reflect the hedging needs driven by the unique risks that businesses encounter.Q.16. One of the arguments for keeping over-the-counter derivatives is the need for customization. What are specific examples of terms that need to be customized because there are no adequate substitutes in the standardized market? Also, what are the actual increased costs of buying those standard contracts?A.16. As noted in the above response to Question 15, standardized contracts list standard delivery dates, maturities and deliverable grades that do not necessarily correspond to the delivery dates and types of exposures market participants need to hedge. Bank loans, for example, are illiquid by their very nature. A creditor bank might wish to reduce its exposure to a particular borrower so as to expand its lending capacity. But if the company in question is relatively small, exchanges will not find it worthwhile to list standardized credit default swaps against that company's loans. At the same time, there might be some investors interested in diversifying their portfolios by taking on an exposure to bank debt. They can do this by buying a portion of the loan, but because bank loans are illiquid trading loans is much more expensive than entering into an over-the-counter credit default swap. More than any other group, restricting trading to standardized derivatives would hurt small businesses. In the area of equity derivatives, investors often use equity swaps to gain exposure to foreign equities because the direct purchase of foreign equities can be very expensive--and in some cases impossible--for an institution without foreign offices (and foreign broking licenses). Thus, restricting trading to standardized contracts traded only in the United States would make it much more difficult and much more costly for U.S. investors to diversify into foreign stocks. The problem would be even more severe in commodity markets. Airlines wishing to hedge jet fuel costs, for example, are often forced to use heating oil futures because the market for jet fuel derivatives is relatively illiquid. Substituting heating oil futures for jet fuel forwards or jet fuel swaps exposes the airline to basis risk. As noted earlier, managing basis risk is a difficult task that typically requires the expertise of professional traders. Simply banning trading in OTC instruments does not guarantee that a liquid market in jet fuel futures would emerge. Moreover, futures markets are typically only liquid for short-term contracts, so that companies such as airlines would find themselves without a way to secure long-term, fixed-price delivery contracts. By offering to provide such custom-tailored contracts, banks supply risk management services to their corporate customers more effectively and at a lower cost than those organizations could do if they had to hire the staff necessary to manage those risks themselves. Managing risks using standardized contracts would require companies to replicate the types of trading and risk management systems typically found only in commodity dealers and banks, and at a very steep cost. More generally, the ability to enter freely into a variety of long-term contracts facilitates the conduct of business. No one can anticipate in advance the terms of all the long-term contracts U.S. companies will find necessary to conduct business, which makes it impossible to list standardized contracts that will address all the needs of all businesses.Q.17. Who is a natural seller of credit protection?A.17. A ``natural'' seller of protection is any entity seeking to profit from being exposed to credit risk of a company, region or industry. Examples of natural sellers include: Institutional investors, pension funds, and insurers, which also invest in corporate bonds. Banks seeking to diversify their sources of income in order to reduce credit concentration. Hedge funds and other investors seeking to profit from perceived overpricing of credit. A seller of credit protection is in an analogous position to a bond holder who has hedged the interest rate risk and, in some cases, exchange rate risk bundled in the bond. The advantage to doing so using credit default swaps instead of buying the bond is that transactions costs typically are smaller and credit default swaps tend to be more liquid than the underlying debt. Credit default swaps may also be available for maturities that would be otherwise unavailable to investors.Q.18. There seems to be agreement that all derivatives trades need to be reported to someone. Who should the trades be reported to, and what information should be reported? And is there any information that should not be made available to the public?A.18. Trades across all derivative asset classes will be reported to various trade information repositories. A repository is accessible in full detail to anyone who regulates the entities who have provided such information to allow the regulator to properly access the risk inherent in the transactions. Aggregated data on open positions and trading volumes will be available to the public. We would direct your attention to http://www.newyorkfed.org/newsevents/news/markets/2009/ma090602.html, which contains a link to the most recent industry letter outlining its commitments to the Federal Reserve Bank of New York, which included commitments regarding trade reporting.Q.19. What is insufficient about the clearinghouse proposed by the dealers and New York Fed?A.19. Please review the ``Report to the Supervisors of the Major OTC Derivatives Dealers on the Proposals on Centralized CDS Clearing Solutions for the Segregation and Portability of Customer CDS Positions and Related Margin'' for a detailed analyses of the relevant clearinghouses. The report can be accessed at http://www.isda.org/credit/docs/Full-Report.pdf. The report highlights some legislative changes that would be desirable to facilitate buy-side access to clearing.Q.20. How do we prevent a clearinghouse or exchange from being too big to fail? And should they have access to Fed borrowing?A.20. These questions are matters of pubic policy that are appropriately decided by legislative and regulatory bodies and not by ISDA or other industry groups. Nonetheless, we respectfully suggest that the possibility of failure is an important element of the market process and that protecting firms from failure can have the paradoxical effect of making individual firms safer while making the financial system less safe. Congress might consider the precedent of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which placed limitations on the ability of regulators to rescue failing banks, subject to a systemic risk exception. Such limitations put the industry on notice that they will have to bear the consequences of unsound practices. But in order for such a policy to be effective, the limitations must be credible; in other words, the industry must know that regulators will not routinely invoke a systemic risk exception when faced with an actual failure. If such a credible policy cannot be achieved, it is difficult to envision circumstances in which the government would not find it necessary to rescue a large central clearinghouse if it ever experienced financial distress. Access to Fed borrowing by the clearinghouse might be necessary to cope with temporary liquidity crises but should not be used as a bailout tool. In order to address the moral hazard issue, policy makers could require that any lending by the Fed could be repaid out of guarantee funds as well as loss sharing arrangements among surviving firms so the losses would ultimately be borne by the industry. The result would be greater incentives for clearinghouse participants to monitor the risks associated with the clearinghouse.Q.21. What price discovery information do credit default swaps provide, when the market is functioning properly, that cannot be found somewhere else?A.21. Credit default swaps have made credit pricing more transparent by means of their price discovery function. First, credit default swaps on diversified credit indexes such as CDX in North America and iTraxx in Europe provide virtually the only price discovery information on credit markets overall, similar to the price discovery information for U.S. equity markets provided by the ability to enter into contracts on such indexes as the S&P 500 and Dow Jones indexes. Second, both single-name credit default swaps and corporate bond markets provide price discovery for individual corporate debt issues, and the two are linked by means of asset swap pricing. Credit default swaps are arguably more liquid than the underlying bond issues, however, and are therefore likely to provide more informative credit pricing than the underlying cash markets. Finally, the uneven liquidity of corporate bonds is a primary reason not only for widespread reliance on credit default swaps for price discovery, but for early warning about impending credit problems as well. While it is true that corporate bond credit spreads also provide early warning, most corporate bonds tend to trade infrequently so the information dispersal is generally less timely than with credit default swaps.Q.22. Selling credit default swaps is often said to be the same as being long in bonds. However, when buying bonds, you have to provide real capital up front and there is a limit to the lending. So it sounds like selling swaps may be a bet in the same direction as buying bonds, but is essentially a highly leveraged bet. Is that the case, and if so, should it be treated that way for accounting purposes?A.22. First, it should be noted that while it is true that an investor who holds a bond bears the same credit risk as the seller of credit default swap protection, the protection seller does not bear the same bundle of risks as a lender or bond investor. In addition to credit risk, a bond investor faces interest rate risk, possibly foreign exchange risk (in the case of a bond denominated in a foreign currency), funding risk (it is worth remembering that many bond investors such as banks and insurance companies are leveraged: they must borrow the funds they use to buy bonds), and liquidity risk (bonds tend to be much less liquid than derivatives referencing those bonds). Therefore, there is no compelling conceptual reason to apply the same accounting treatment to credit default swaps and bonds based on an equivalence of risks. Moreover, as discussed in response to Question 10 above, it is simply infeasible to apply the same accounting treatment to off-balance-sheet instruments such as credit default swaps as to transactions involving cash securities. Companies can and do report their off-balance-sheet exposures; existing bank regulatory capital requirements already limit the effective leverage that can be created using derivatives. To the extent that existing regulations have not always been applied effectively in the past, or to the extent that they have not been applied uniformly to financial companies in all industries, this is an issue best addressed through more uniform and effective regulation and supervision and more effective risk management. Mandating changes to accounting standards is not a solution. Existing accounting standards were originally devised as expense tracking systems and are not a substitute for capital requirements. Therefore, mandating changes to accounting standards in contravention of conventions established by existing professional rulemaking bodies would likely prove an ineffective method of improving risk management practices.Q.23. Why should we have two regulators of derivatives, with two interpretations of the laws and regulations? Doesn't that just lead to regulation shopping and avoidance?A.23. Regulation of the derivatives markets is a part of the broader public policy debate over the financial regulatory reform. Federal regulation of securities, commodities, exchanges, and derivatives has developed over time and reflects the evolution of the capital markets. In its white paper released last month, the Administration supports the harmonization of futures and securities regulation, proposing the CFTC and the SEC make recommendations to Congress for changes to statutes and regulations that would harmonize regulation of futures and securities. The SEC and CFTC are expected to complete a report to Congress on this issue by the end of September. As Congress considers these recommendations, we submit that inconsistency between regulatory requirements and enforcement of those requirements, for generally equivalent instruments or activities leads to costly uncertainties. Reporting requirements, filing requirements, and approval standards should be harmonized as much as possible. Harmonized standards are necessary to enhance the quality of regulation by the primary Federal regulators and any systemic risk regulator. Finally, the derivatives markets are global and require cooperation among the international markets' regulators. Coordination among regulators at the Federal Government level is critical to successful coordination on the international level. Toward this end, any regulatory reform restructuring that will be passed by Congress should include provisions to preempt State initiatives on the regulation of derivatives instruments, users, and markets.Q.24. Why is synthetic exposure through derivatives a good idea? Isn't that just another form of leverage?A.24. Please see the response to Question 11.Q.25. What is good about the Administration proposal?A.25. The Administration's proposal is an important step toward much-needed reform of financial industry regulation. ISDA and the industry welcome the Administration's recognition of industry measures to safeguard smooth functioning of our markets and its support of the customized OTC derivatives as tools needed by companies to meet their specific needs. ISDA supports appropriate regulation of financial and other institutions that have such a large presence in the financial system that their failure could cause systemic concerns. For nearly 4 years, the industry has been engaged in a dialogue with the Federal Reserve that has resulted in ISDA and the industry committing to strengthening the resilience and robustness of the OTC derivatives markets through the implementation of changes to risk management, processing and transparency that will significantly transform the risk profile of these important financial markets. Specifically, the industry has undertaken to increase standardization of trading terms, improve the trade settlement process, bring more clarity to the settlement of defaults, move toward central counterparty clearing where appropriate, enhance transparency, and enhance openness in the industry's governance structure. All of these initiatives are consistent with the Administration's proposals. We would direct your attention to http://www.newyorkfed.org/newsevents/news/markets/2009/ma090602.html, which contains a link to the most recent industry letter outlining its commitments to the Federal Reserve Bank of New York.Q.26. Is the Administration proposal enough?A.26. Please see answer to 25 above.Q.27. Mr. Whalen suggests that Congress should subject all derivatives to the Commodity Exchange Act, at least as an interim step. Is there any reason we should not do it?A.27. Here is an extract from Mr. Whalen's testimony: ``Congress should subject all OTC contracts to The Commodity Exchange Act (CEA) and instruct the CFTC to begin the systematic review and rule making process to either conform OTC markets to minimum standards of disclosure, collateral and transparency, or require that the contracts be migrated onto organized, bilateral exchanges.'' ISDA disagrees with Mr. Whalen's suggestion, which would turn the clock back almost two decades by reintroducing substantial legal and regulatory uncertainty into derivatives activity and to financial markets in general. The problem is that the CEA is unclear about which financial instruments are and are not futures as defined in the CEA, so extensive discretion is left to the Commodity Futures Trading Commission (CFTC) to decide. The extreme possibility is that an over-the-counter derivatives will be found to be an off-exchange futures contract and therefore illegal. Although the CFTC has the authority to carve out exceptions to the exchange trading requirement, the exceptions themselves are subject to uncertainty because they can be subsequently narrowed and possibly even revoked. The result is that parties seeking to manage their risk with OTC derivatives are forced to do so under the cloud that their transaction could at a later date be declared null and void, which can have potentially disastrous consequences for the firms involved. We submit instead that the Commodity Futures Modernization Act appropriately cleared up much of the legal and regulatory uncertainty surrounding the CEA while leaving CFTC with sufficient authority to address fraud and market manipulation concerns. Returning to an earlier era of legal uncertainty would unnecessarily increase the risks faced by market participants. Further, forcing useful but relatively less liquid products onto exchanges might in many cases doom such products to failure because they cannot generate sufficient volume to support continuous trading.Q.28. Is there anything else you would like to say for the record?A.28. ISDA and the OTC derivatives industry are committed to engaging with Congress to build upon the substantial improvements that have been made in our business since 2005. We will continue to support efforts of Congress, the regulators and the Administration to determine the most effective prudential regulation of this important industry. Changes to the OTC derivatives industry should be informed by an understanding of how the OTC derivatives market functions as well as a recognition that OTC derivatives play an important role in the U.S. economy. OTC derivatives offer significant value to the customers who use them, to the dealers who provide them, and to the financial system in general by enabling the transfer of risk between counterparties. Ultimately, it is important to maintain the continued availability and affordability of these important tools. ------ CHRG-111hhrg56847--98 Mr. Simpson," Thank you, Mr. Chairman. And thank you for being here today, Chairman. The economy seems to react to almost everything you say. Sometimes it reacts to things Congress does or fails to do. You said earlier that we need a plan to deal with our--or at least a plan to deal with our long-term financial debt as important to current economic conditions. Is that correct? " CHRG-110shrg50414--218 Mr. Bernanke," No, but if you make it a condition of participation in the valuation process, that is going to--that is essentially going to cause some not to participate when they would otherwise be part of the competitive valuation process. " CHRG-111hhrg56766--235 Mr. Bernanke," It is a very hard question. Certainly, you want to have humane conditions. Low income is a fact of life in poor countries and sometimes trade is an opportunity to better yourself. " CHRG-110hhrg44900--100 Mrs. Biggert," I guess I was concerned because you said that if current unusual circumstances continue to prevail. So did you think that if it were right now that you would want to extend that--condition such? " FOMC20080916meeting--211 209,MS. DANKER.," I will be reading the directive from the Bluebook and the statement that was just circulated. ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 2 percent."" Then the statement is as it was handed out, except the last sentence reads, ""The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability."" Chairman Bernanke First Vice President Cumming Governor Duke President Fisher Governor Kohn Governor Kroszner President Pianalto President Plosser President Stern Governor Warsh Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes " CHRG-111shrg52619--169 PREPARED STATEMENT OF MICHAEL E. FRYZEL Chairman, National Credit Union Administration March 19, 2009Introduction As Chairman of the National Credit Union Administration (NCUA), I appreciate this opportunity to provide my position on ``Modernizing Bank Supervision and Regulation.'' Federally insured credit unions comprise a small but important part of the financial institution community, and NCUA's perspective on this matter will add to the overall understanding of the needs of the credit union industry and the members they serve. \1\--------------------------------------------------------------------------- \1\ 12 U.S.C. 1759. Unlike other financial institutions, credit unions may only serve individuals within a restricted field of membership. Other financial institutions serve customers that generally have no membership interest.--------------------------------------------------------------------------- As NCUA Chairman, I agree with the need for establishing a regulatory oversight entity (systemic risk regulator) whose responsibilities would include monitoring the financial institution regulators and issuing principles-based regulations and guidance. I envision this entity would be responsible for establishing general safety and soundness guidance for federal financial regulators under its control while the individual federal financial regulators would implement and enforce the established guidelines in the institutions they regulate. This entity would also monitor systemic risk across institution types. For this structure to be effective for federally insured credit unions, the National Credit Union Share Insurance Fund (NCUSIF) must remain independent of the Deposit Insurance Fund to maintain the dual regulatory and insurance roles for the NCUA that have been tested and proven to work in the credit union industry for almost 40 years. The NCUA's primary mission is to ensure the safety and soundness of federally insured credit unions. It performs this important public function by examining all federal credit unions, participating in the examination and supervision of federally insured state chartered credit unions in coordination with state regulators, and insuring federally insured credit union members' accounts. In its statutory role as the administrator of the NCUSIF, the NCUA insures and supervises 7,806 federally insured credit unions, representing 98 percent of all credit unions and approximately 88 million members. \2\--------------------------------------------------------------------------- \2\ Approximately 162 state-chartered credit unions are privately insured and are not subject to NCUA oversight. Based on December 31, 2008, Call Report (NCUA Form 5300) data.--------------------------------------------------------------------------- Overall, federally insured, natural person credit unions maintained reasonable financial performance in 2008. As of December 31, 2008, federally insured credit unions maintained a strong level of capital with an aggregate net worth ratio of 10.92 percent. \3\ While earnings decreased from prior levels due to the economic downturn, federally insured credit unions were able to post a 0.30 percent return on average assets in 2008. \4\ Delinquency was reported at 1.37 percent, while net charge-offs was 0.84 percent. \5\ Shares in federally insured credit unions grew at 7.71 percent with membership growing at 2.01 percent, and loans growing at 7.08 percent. \6\--------------------------------------------------------------------------- \3\ Based on December 31, 2008, Call Report (NCUA Form 5300) data. \4\ Ibid. \5\ Ibid. \6\ Ibid.---------------------------------------------------------------------------Federally Insured Credit Unions Require Separate Oversight Federally insured credit unions' unique cooperative, not-for-profit structure and statutory mandate of serving people of modest means necessitate a customized approach to their regulation and supervision. The NCUA should remain an independent agency to preserve the credit union model and protect credit union members as mandated by Congress. An agency responsible for all financial institutions might focus on the larger financial institutions where the systemic risk predominates, potentially to the detriment of smaller federally insured credit unions. As federally insured credit unions are generally the smaller, less complex institutions in a consolidated financial regulator arrangement, the unique character of credit unions would quickly be lost, absorbed by the for-profit model and culture of the banking system. Federally insured credit unions fulfill a specialized role in the domestic marketplace; one that Congress acknowledged is important in assuring consumers have access to basic financial services such as savings and affordable credit products. Loss of federally insured credit unions as a type of financial institution would limit access to these affordable financial services for persons of modest means. Federally insured credit unions serve an important competitive check on for-profit institutions by providing low-cost products and services. Some researchers estimate the competitive presence of credit unions save bank customers $4.3 billion annually. \7\ Research also shows that in many markets, credit unions provide a lower cost alternative to abusive and predatory lenders. The research describes the fees, rates, and terms of the largest United States credit card providers in comparison to credit cards issued by credit unions with similar purchase interest rates but with fewer fees, lower fees, lower default rates, and clearer disclosures. The details of credit union credit card programs show credit card lending is sustainable without exorbitant penalties and misleading terms and conditions. \8\--------------------------------------------------------------------------- \7\ An Estimate of the Influence of Credit Unions on Bank CD and Money Market Deposits in the U.S.--Idaho State University, January 2005. Also, An Analysis of the Benefits of Credit Unions to Bank Loan Customers--American University, January 2005. \8\ Blindfolded Into Debt: A Comparison of Credit Card Costs and Conditions at Banks and Credit Unions. The Woodstock Institute, July 2005.--------------------------------------------------------------------------- Federally insured credit unions provide products geared to the modest consumer at a reasonable price, such as very small loans and low-minimum balance savings products that many banks do not offer. Credit unions enter markets that other financial institutions have not entered or abandoned because these markets were not profitable or there were more lucrative markets to pursue. \9\ Loss of credit unions would reduce service to underserved consumers and hinder outreach and financial literacy efforts.--------------------------------------------------------------------------- \9\ Increase in Bank Branches Shortchanges Lower-Income and Minority Communities: An Analysis of Recent Growth in Chicago Area Bank Branching. The Woodstock Institute, February 2005, Number 27.--------------------------------------------------------------------------- When comparing the size and complexity of federally insured credit unions to banks, even the largest federally insured credit unions are small in comparison. As shown in the graph below, small federally insured credit unions make up the majority of the institutions the NCUA insures. Eighty-four percent of federally insured credit unions have less than $100 million in assets as opposed to 38 percent of the institutions that the Federal Deposit Insurance Corporation (FDIC) insures with the same asset size. \10\ Total assets in the entire federally insured credit union industry are less than the individual total assets of some of the nation's largest banks. \11\--------------------------------------------------------------------------- \10\ FDIC Quarterly Banking Profile--Fourth Quarter 2008. \11\ December 31, 2008, total assets for federally insured credit unions equaled $813.44 billion, while total assets for federally insured banks equaled $13.85 trillion. Based on December 31, 2008, Call Report (NCUA Form 5300) data and FDIC Quarterly Banking Profile--Fourth Quarter 2008.---------------------------------------------------------------------------Specialized Supervision In recognition of the importance of small federally insured credit unions to their memberships, the NCUA established an Office of Small Credit Union Initiatives to foster credit union development, particularly in the expansion of services provided by small federally insured credit unions to all eligible members. Special purpose programs have helped preserve the viability of several institutions by providing access to training, grant assistance, and mentoring. \12\--------------------------------------------------------------------------- \12\ NCUA 2007 Annual Report.--------------------------------------------------------------------------- The NCUA has developed expertise to effectively supervise federally insured credit unions. The agency has a highly trained examination force that understands the intricacies and nuances of federally insured credit unions and their operations. The NCUA's mission includes serving and maintaining a safe, secure credit union community. In order to accomplish this, the NCUA has put in place specialized programs such as the National Examination Team to supervise federally insured credit unions showing a higher risk to the NCUSIF, Subject Matter Examiners to address specific areas of risk, and Economic Development Specialists to provide hands-on assistance to small federally insured credit unions.NCUA's Tailored Guidance Approach The systemic risk regulator would set the general safety and soundness guidelines, while the NCUA would monitor and enforce the specific rules for the federally insured credit union industry. For example, the NCUA has long recognized the safety and soundness issues regarding real estate lending. Real estate lending makes up fifty-four percent of federally insured credit unions' lending portfolio. As a result, the NCUA has provided federally insured credit unions detailed guidance regarding this matter. The below chart outlines the regulatory approach taken with real estate lending. As demonstrated by the guidance issued, the NCUA proactively addresses issues with the industry as they evolve and as they specifically apply to federally insured credit unions. Due to federally insured credit unions' unique characteristics, the NCUA should be maintained as a separate regulator under an overseeing entity to ensure the vital sector of federally insured credit unions is not ``lost in the shuffle'' of the financial institution industry as a whole.Maintain Separate Insurance Fund Funds from federally insured credit unions have established the NCUSIF. The required deposit is calculated at least annually at one percent of each federally insured credit union's insured shares. The fund is commensurate with federally insured credit unions' equity interests and the risk level in the industry. The small institutions that make up the vast majority of federally insured credit unions should not be required to pay for the risk taken on by the large conglomerates. The NCUA has a successful record of regulating federal credit union charters and also serving as insurer for all federally insured credit unions. This structure has stood the test of time, encompassing various adverse economic cycles. The NCUA is the only regulator with this 100 percent dual regulator/insurer role. The overall reporting to a single regulatory body creates a level of efficiency for federally chartered credit unions in managing the regulatory relationship. This unique role has allowed the NCUA to develop economies of scale as a federal agency. The July 1991 Government Accountability Office (GAO) report to Congress considered whether NCUA's insurance function should be separated from the other functions of chartering, regulating, and supervising credit unions. The GAO concluded ``[s]eparation of NCUSIF from NCUA's chartering, regulation, and supervision responsibilities would not, on the basis of their analyses, by itself guarantee either strong supervision or insurance fund health. And such a move could result in additional and duplicative oversight costs. In addition, it could be argued that a regulator/supervisor without insurance responsibility has less incentive to concern itself with the insurance costs, should an institution fail.'' \16\--------------------------------------------------------------------------- \16\ GAO, July 1991 Study.--------------------------------------------------------------------------- The 1997 Treasury study reached conclusions similar to the GAO report. The Treasury study discussed the unique capitalization structure of the NCUSIF and how it fits the cooperative nature of federally insured credit unions and offered the following: \17\--------------------------------------------------------------------------- \17\ Treasury, December 1997 Study of Credit Unions. We found no compelling case for removing the Share Insurance Fund from the NCUA's oversight and transferring it to another federal agency such as the FDIC. The NCUA maintains some level of separation between its insurance activities and its other responsibilities by separating the operating costs of the Fund from its noninsurance expenses. \18\--------------------------------------------------------------------------- \18\ Treasury, December 1997 Study of Credit Unions, page 52. Under the current structure, the NCUA can use supervision to control risks taken by credit unions--providing an additional measure of protection for the Fund. We also believe that separating the Fund from the NCUA could: (1) reduce the regulator's incentives to concern itself with insurance costs, should an institution fail; (2) create possible confusion over the roles and responsibilities of the insurer and of the regulator; and (3) place the insurer in the situation of safeguarding the insurance fund without having control over the risks taken by the insured entities. \19\--------------------------------------------------------------------------- \19\ Ibid, page 52. The financing structure of the Share Insurance Fund fits the cooperative character of credit unions. Because credit unions must expense any losses to the Share Insurance Fund, they have an incentive to monitor each other and the Fund. This financing structure makes transparent the financial support that healthier credit unions give to the members of failing credit unions. Credit unions understand this aspect of the Fund and embrace it as a reflection of their cooperative character. \20\--------------------------------------------------------------------------- \20\ Ibid, page 58. The unique dual regulatory role in which the NCUA operates has proven successful in the credit union industry. At no time under this structure has the credit union system cost the American taxpayers any money.Federally Insured Credit Unions Demonstrate Unique Characteristics Federally insured credit unions are unique financial institutions that exist to serve the needs of their members. The statutory and regulatory frameworks in which federally insured credit unions operate reflect their uniqueness and are significantly different from that of other financial institutions. Comments that follow in this section provide specific examples for federal credit unions. However, most of the examples also apply to federally insured state chartered credit unions because of their similar organization as institutions designed to promote thrift. \21\--------------------------------------------------------------------------- \21\ 12 U.S.C. 1781(c)(1)(E).---------------------------------------------------------------------------One Member One Vote The federal credit union charter is the only federal financial charter in the United States that gives every member an equal voice in how their institution is operated regardless of the amount of shares on deposit with its ``one member, one vote'' cooperative structure. \22\ This option allows federal credit unions to be democratically governed. The federal credit union charter provides an important pro-consumer alternative in the financial services industry.--------------------------------------------------------------------------- \22\ 12 U.S.C. 1760.---------------------------------------------------------------------------Field of Membership Federal credit unions are not-for-profit, member-owned cooperatives that exist to provide their members with the best possible rates and service. A federal credit union is chartered to serve a field of membership that shares a common bond such as the employees of a company, members of an association, or a local community. Therefore, federal credit unions may not serve the general public like other financial institutions and the federal credit unions' activities are largely limited to domestic activities, which has minimized the impact of globalization in the federal credit union industry. Due to this defined and limited field of membership, federal credit unions have less ability to grow into large institutions as demonstrated by 84 percent of federally insured credit unions having less than $100 million in assets. \23\--------------------------------------------------------------------------- \23\ Based on December 31, 2008, Call Report (NCUA Form 5300) data.---------------------------------------------------------------------------Volunteer Board of Directors Federal credit unions are managed largely on a volunteer basis. The board of directors for each federal credit union consists of a volunteer board of directors elected by, and from the membership. \24\ By statute, no member of the board may be compensated as such; however, a federal credit union may compensate one individual who serves as an officer of the board. \25\--------------------------------------------------------------------------- \24\ 12 U.S.C. 1761(a). \25\ 12 U.S.C. 1761(c).---------------------------------------------------------------------------Consumer Protection The Federal Credit Union Act requires federal credit union boards of directors to appoint not less than three members or more than five members to serve as members of the supervisory committee. \26\ The purpose of the supervisory committee is to ensure independent oversight of the board of directors and management and to advocate the best interests of the members. The supervisory committee either performs or contracts with a third-party to perform an annual audit of the federal credit union's books and records. \27\ The supervisory committee also plays an important role as the member advocate.--------------------------------------------------------------------------- \26\ 12 U.S.C. 1761b. \27\ 12 U.S.C. 1761d.--------------------------------------------------------------------------- As the member advocate, the supervisory committee is charged with reviewing member complaints. \28\ Complaints cover a broad spectrum of areas, including annual meeting procedures, dividend rates and terms, and credit union services. Regardless of the nature of the complaint, NCUA requires supervisory committees to conduct a full and complete investigation. When addressing member complaints, supervisory committees will determine the appropriate course of action after thoroughly reviewing the unique circumstances surrounding each complaint. \29\--------------------------------------------------------------------------- \28\ As noted in the preamble of final rule incorporating the standard federal credit union bylaws into NCUA Rules and Regulations Part 701. \29\ Supervisory Committee Guide, Chapter 4, Publication 4017/8023 Revised December 1999.--------------------------------------------------------------------------- This committee and function of member advocacy are unique to federal credit unions. No member of the supervisory committee can be compensated. \30\--------------------------------------------------------------------------- \30\ 12 U.S.C. 1761.---------------------------------------------------------------------------Regulatory Limitations While there have been significant changes in the financial services environment since 1934 when the Federal Credit Union Act was implemented, federal credit unions have only had modest gains in the breadth of services offered relative to the broad authorities and services of other financial institutions. By virtue of their enabling legislation along with regulations established by the NCUA, federal credit unions are more restricted in their operation than other financial institutions. A discussion of some of these limitations follows.Investment Limitations Federal credit unions have relatively few permissible investment options. Investments are largely limited to United States debt obligations, federal government agency instruments, and insured deposits. \31\ Federal credit unions cannot invest in a diverse range of higher yielding products, including commercial paper and corporate debt securities. Also, federal credit unions have limited authority for broker-dealer relationships. \32\ These limitations have helped credit unions weather the current economic downturn.--------------------------------------------------------------------------- \31\ NCUA Rules and Regulations Part 703. \32\ NCUA Rules and Regulations Part 703.---------------------------------------------------------------------------Affiliation Limitations Federal credit unions are much more limited than other financial institutions in the types of businesses in which they engage and in the kinds of affiliates with which they deal. Federal credit unions cannot invest in the shares of an insurance company or control another financial depository institution. Also, they cannot be part of a financial services holding company and become affiliates of other depository institutions or insurance companies. Federal credit unions are limited to only the powers established in the Federal Credit Union Act. \33\--------------------------------------------------------------------------- \33\ 12 U.S.C. 1757.---------------------------------------------------------------------------Capital Limitations Unlike other financial institutions, federal credit unions cannot issue stock to raise additional capital. \34\ Also, federal credit unions have borrowing authority limited to 50 percent of paid-in and unimpaired capital and surplus. \35\--------------------------------------------------------------------------- \34\ 12 U.S.C. 1790d(b)(1)(B)(i). \35\ 12 U.S.C. 1757(9).--------------------------------------------------------------------------- A federal credit union can only build net worth through its retained earnings, unless it is a low-income designated credit union that can accept secondary capital contributions. \36\ Federally insured credit unions must also hold 200 basis points more in capital than other federally insured financial institutions in order to be considered ``well-capitalized'' under federal ``Prompt Corrective Action'' laws. \37\ In addition, federal credit unions must transfer their earnings to net worth and loss reserve accounts or distribute it to their membership through dividends, relatively lower loan rates, or relatively lower fees.--------------------------------------------------------------------------- \36\ 12 U.S.C. 1790d(o)(2)(B). \37\ 12 U.S.C. 1790d.---------------------------------------------------------------------------Lending Limitations Federal credit unions are not permitted to charge a prepayment penalty in any type of loan whether consumer or business. \38\ With the exception of certain consumer mortgage loans, federal credit unions cannot make loans with a maturity greater than 15 years. \39\ Also, federal credit unions are subject to a federal statutory usury, currently set at 18 percent, which is unique among federally chartered financial institutions and far more restrictive than state usury laws. \40\--------------------------------------------------------------------------- \38\ 12 U.S.C. 1757(5)(viii). \39\ 12 U.S.C. 1757(5). \40\ 12 U.S.C. 1757(5)(A)(vi).--------------------------------------------------------------------------- While federal credit unions have freedom in making consumer and mortgage loans to members, except with regard to limits to one borrower and loan-to-value restrictions, they are severely restricted in the kind and amount of member business loans they can underwrite. Some member business lending limits include restrictions on the total amount of loans, loan to value requirements, construction loan limits, and maturity limits. \41\--------------------------------------------------------------------------- \41\ 12 U.S.C. 1757a and NCUA Rules and Regulations Part 723.---------------------------------------------------------------------------Access to Credit Despite regulatory constraints, federally insured credit unions continue to follow their mission of providing credit to persons of modest means. Amid the tightening credit situation facing the nation, federally insured credit unions have continued to fulfill their members' borrowing needs. While other types of lenders severely curtailed credit, federally insured credit unions experienced a 7.08 percent loan growth in 2008. Credit unions remain fundamentally different from other forms of financial institutions based on their member-owned, democratically operated, not-for-profit cooperative structure. Loss of credit unions as a type of financial institution would severely limit the access to financial services for many Americans.Regulatory Framework Recommendation I agree with the need for establishing a regulatory oversight entity to help mitigate risk to our nation's financial system. It is my recommendation that Congress maintain multiple financial regulators and charter options to enable the continued checks and balances such a structure produces. The oversight entity's main functions should be to establish broad safety and soundness principles and then monitor the individual financial regulators to ensure the established principles are implemented. This structure also allows the oversight entity to set objective-based standards in a more proactive manner, and would help alleviate competitive conflict detracting from the resolution of economic downturns. This type of structure would also promote uniformity in the supervision of financial institutions while affording the preservation of the different segments of the financial industry, including the credit union industry.Conclusions Federally insured credit union service remains focused on providing basic and affordable financial services to members. Credit unions are an important, but relatively small, segment of the financial institution industry serving a unique niche. \42\ As a logical extension to this, the NCUSIF, which is funded by the required insurance contributions of federally insured credit unions, should be kept separate from any bank insurance fund. This would maintain an appropriate level of diversification in the financial system.--------------------------------------------------------------------------- \42\ As of December 31, 2008, approximately $14.67 trillion in assets were held in federally insured depository institutions. Banks and other savings institutions insured by the FDIC held $13.85 trillion, or 94.44 percent of these assets. Credit unions insured by the NCUSIF held $813.44 billion, or 5.56 percent of all federally insured assets.--------------------------------------------------------------------------- While the NCUA could be supportive of a regulatory oversight entity, the agency should maintain its dual regulatory functions of regulator and insurer in order to ensure the federally insured credit union segment of the financial industry is preserved. ______ CHRG-111shrg54589--6 STATEMENT OF SENATOR MIKE CRAPO Senator Crapo. First of all, Mr. Chairman, let me thank you for holding this hearing. I believe that although there is a breadth of derivative action in our economy, I believe that a significant amount, if not the significant majority of the amount of those transactions falls under the jurisdiction of this Committee, and I appreciate your attention to that fact. I also agree with the comments that both the Chairman and Ranking Member have made. Recent events in the credit markets have highlighted the need for greater attention to risk management practices, and counterparty risk in particular; and although I agree with the need to focus on where we can standardize and the types of risk reduction and better practices that we need to address, I also want in my remarks to just focus very quickly on one specific part of it, and that is, not letting the pendulum swing too far to the other side to where we cause damage to an efficient economy. The creation of clearinghouses and increased information to trade information warehouses are positive steps to strengthen the infrastructure for clearing and settling credit default swaps. While central counterparty clearing and the exchange trading of simple standardized contracts has the potential to reduce risk and increase market efficiency, market participants must be permitted to continue to negotiate customized bilateral contracts in over-the-counter markets. Many businesses use over-the-counter derivatives to minimize the impact of commodity price, interest rate, and exchange rate volatility in order to maintain stability in earnings and predictability in their operations. If Congress overreaches or bans or generates significant uncertainty with regard to the legitimacy of decisions to customize individual OTC derivatives transactions, I believe there could be very significant negative implications on how companies manage risk. In the contemplation of this hearing and this issue, Mr. Chairman, I actually requested that a number of the end users of these types of transactions respond to a question about what increased flexibility or reduction of flexibility would do, and at this time, I would like to just share three or four examples of the responses that I received. David Dines, the President of Cargill Risk Management, indicates, ``While margining and other credit support mechanisms are in place and utilized every day in the OTC markets, there is flexibility in the credit terms, the credit thresholds and types of collateral that can be applied. This flexibility is a significant benefit for end users of OTC derivatives such as Cargill in managing working capital. Losing this flexibility is particularly concerning because mandatory margining will divert working capital from investments that can grow our business and idle it in margin accounts. While it depends on market conditions, the diversion of working capital from Cargill for margining could be in excess of $1 billion. Multiply this across all companies in the United States and the ramifications are enormous, especially at a time when credit is critically tight.'' Kevin Colgan, the Corporate Treasurer of Caterpillar: ``Our understanding of currently pending regulation in this area is that it would require a clearing function which would standardized terms like `duration' and `amount.' Any standardization of this type would prohibit us from matching exactly the terms and underlying exposure we are attempting to hedge. Thus, in turn it would expose us to uncovered risk and introduce needless volatility into our financial crisis.'' I have a number of other examples which I will insert for the record, Mr. Chairman. " FOMC20080318meeting--198 196,MS. DANKER.," The vote will encompass the directive I'll read from the Bluebook and the statement for alternative A in the chart that you have in front of you. ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 2� percent."" Chairman Bernanke Vice Chairman Geithner President Fisher Governor Kohn Governor Kroszner Governor Mishkin President Pianalto President Plosser President Stern Governor Warsh Yes Yes No Yes Yes Yes Yes No Yes Yes " FOMC20080625meeting--181 179,MS. DANKER.," Yes. This vote applies to the directive as well as the language of the statement in alternative B of exhibit 1. ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 2 percent."" Chairman Bernanke Vice Chairman Geithner President Fisher Governor Kohn Governor Kroszner Governor Mishkin President Pianalto President Plosser President Stern Governor Warsh Yes Yes No Yes Yes Yes Yes Yes Yes Yes " FOMC20080916meeting--151 149,MR. KOHN.," Thank you, Mr. Chairman. I think that, even before the recent intensification of financial market turmoil, there were trends becoming increasingly evident over the summer, since late June, that suggested that the economy was on a substantially slower path than it had been before. Resource utilization was falling appreciably, and the expected downward path of inflation in the future had much better odds of occurring. Indeed, I think that the expected weakness in the economy and the financial markets are interacting. We have one of these feedback loops in play. There has been a lot of concern not only in the United States but in other countries as well, as I heard in Basel last weekend, about a spillover--that the problems were not confined to the mortgage markets but were spilling into the loan books of the banks. That was related to the weakening in economic activity and was tightening up credit conditions, which would, in turn, further weaken economic activity. So this feedback loop was at work certainly in the United States and was beginning to be felt a little more in other countries as well. Since late June we have come to know a couple of things a little better. One is that consumption is not immune to soft labor markets, increases in energy prices, declining housing wealth, and tighter borrowing conditions. Even if we can't parse out the effects of each of these factors, consumption has weakened substantially. We have had three months in a row of declines in the retail control component and very weak auto sales. Although recent declines in oil prices will support disposable incomes and consumption, I think the other sources of restraint on households-- declining house prices and tighter credit conditions--are more likely to intensify than to abate in coming quarters. Another thing we know is that businesses have not gotten ahead of their need to shed labor, and they continue to trim staff in response to actual and expected weakness in demand. The decline in employment shows no signs of abating. Initial claims are running more than 50,000 higher than they were at the end of June, and they have remained elevated past the time that the introduction of the temporary extended benefits should have been felt. The unemployment rate is already � percentage point higher than anyone around this table predicted for the end of the year. The household survey, along with national income statistics, could be signaling greater softness in activity and higher output gaps than is evident in the GDP and spending data. Another thing we have learned, as Nathan emphasized, is that foreign economies have not decoupled from the United States, and their prospects have been revised down substantially. They're absorbing the effects of weaker U.S. domestic demand on their exports, and growing risk aversion in financial markets is spreading abroad. The latter, the growing risk aversion, is beginning to have, as Chris Cumming was noting, effects on a number of emerging-market economies, where capital inflows show signs of abating or even reversing; and indicators of financial stress have risen as a consequence of all this. Because of the stronger dollar, we will be able to rely less on exports going forward than we did before. We never expected a rapid return to more normal financial market functioning, but the adjustment in the financial sector now looks to be more severe and to take longer than we thought before. Financial firms need to bolster profits to offset losses and track capital. They need to delever by reducing debt relative to equity. They need to consolidate, and above all, they need to protect themselves against the possibility of a run. All of this implies a prolonged period of very cautious lending and a high cost of capital for borrowers relative to benchmark interest rates. If the current severe financial situation persists, I think the flight to safety and liquidity could dry up credit to a broad array of all but the very safest borrowers and reduce asset prices with feedbacks on spending, and that feedback loop could intensify if these market conditions pertain. I think that's a substantial downside risk to the growth outlook. Not all news affecting spending has been negative. Capital goods orders have held up. The decline in interest rates and commodity prices that respond to the markdown in global growth will help support domestic demand, and actions to stabilize the GSEs are helping the mortgage market. Activity is more likely to stagnate than to decline. But I think that we can be more certain than we were, say, at the end of June that the economy will move substantially away from our high employment objective over the next several quarters and that the downside risks to that are larger. On the inflation side, incoming data have been disappointing, a little worse than anticipated, perhaps suggesting greater pass-through. The rise in import prices at the beginning of the third quarter was higher than anticipated. But we've also learned over the last couple of months that oil and other commodity prices can go down as well as up. The drop in retail energy prices helped to reverse much of the run-up in inflation expectations at the household level and reduced inflation compensation in financial markets at least over the next five years. Weaker economies, along with lower commodity prices, are expected to reduce inflation in our trading partners, and that along with the dollar should lower import price inflation. The broadest measures of labor compensation available through the second quarter continue to suggest no upward pressure on the pace of increases in nominal labor costs. Despite elevated headline inflation, surprisingly good growth of productivity is holding down unit labor costs. Taking all of this together, I think that, despite the incoming inflation data, we can have greater confidence in our forecast that inflation will decline late this year and run much lower in the next few years than in the past year or so, though the risks to that still lie on the upside until we actually see the decline in headline inflation persist. On policy, Mr. Chairman, I support alternative B, keeping the funds rate at 2 percent. I think that, at least for now, is consistent with lower inflation and a slow return to full employment in the future over time. We need to assess the effects of the financial turmoil. If asset price declines accelerate and the tightening of financial conditions is large and likely to be sustained, I would be open at some point in the future to a lowering of interest rates. Thank you, Mr. Chairman. " FOMC20080121confcall--12 10,CHAIRMAN BERNANKE.," Certainly. Let me do that. I had one word in the second paragraph--the word ""broader""--which I will come to. ""The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3� percent. The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader--add that word--financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets. The Committee expects inflation to moderate in coming quarters, but it will continue to monitor inflation developments carefully. Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks."" President Evans. " FOMC20070131meeting--370 368,MS. MINEHAN.," Thank you. That was really interesting, Janet. Your recommendation would be not to condition on a common policy path but have “appropriate policy.” So in the end when we publish the forecasts, would it be a range of federal funds rates?" fcic_final_report_full--433 Some combination of the first two factors may apply in parts of the Sand States, but these don’t explain the nationwide increase in prices. The closely related and nationwide mortgage bubble was the largest and most sig- nificant manifestation of a more generalized credit bubble in the United States and Eu- rope. Mortgage rates were low relative to the risk of losses, and risky borrowers, who in the past would have been turned down, found it possible to obtain a mortgage.  In addition to the credit bubble, the proliferation of nontraditional mortgage products was a key cause of this surge in mortgage lending. Use of these products in- creased rapidly from the early part of the decade through . There was a steady deterioration in mortgage underwriting standards (enabled by securitizers that low- ered the credit quality of the mortgages they would accept, and credit rating agencies that overrated the subsequent securities and derivatives). There was a contemporane- ous increase in mortgages that required little to no documentation. As house prices rose, declining affordability would normally have constrained demand, but lenders and borrowers increasingly relied on nontraditional mortgage products to paper over this affordability issue. These mortgage products included interest-only adjustable rate mortgages (ARMs), pay-option ARMs that gave bor- rowers flexibility on the size of early monthly payments, and negative amortization products in which the initial payment did not even cover interest costs. These exotic mortgage products would often result in significant reductions in the initial monthly payment compared with even a standard ARM. Not surprisingly, they were the mortgages of choice for many lenders and borrowers focused on minimizing initial monthly payments. Fed Chairman Bernanke sums up the situation this way: “At some point, both lenders and borrowers became convinced that house prices would only go up. Bor- rowers chose, and were extended, mortgages that they could not be expected to serv- ice in the longer term. They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ulti- mately, further appreciation could not be sustained and house prices collapsed.”  This explanation posits a relationship between the surge in housing prices and the surge in mortgage lending. There is not yet a consensus on which was the cause and which the effect. They appear to have been mutually reinforcing. In understanding the growth of nontraditional mortgages, it is also difficult to de- termine the relative importance of causal factors, but again we can at least list those that are important: • Nonbank mortgage lenders like New Century and Ameriquest flourished un- der ineffective regulatory regimes, especially at the state level. Weak disclosure standards and underwriting rules made it easy for irresponsible lenders to issue mortgages that would probably never be repaid. Federally regulated bank and thrift lenders, such as Countrywide, Wachovia, and Washington Mutual, had lenient regulatory oversight on mortgage origination as well. • Mortgage brokers were paid for new originations but did not ultimately bear the losses on poorly performing mortgages. Mortgage brokers therefore had an incentive to ignore negative information about borrowers. • Many borrowers neither understood the terms of their mortgage nor appreci- ated the risk that home values could fall significantly, while others borrowed too much and bought bigger houses than they could ever reasonably expect to afford. • All these factors were supplemented by government policies, many of which had been in effect for decades, that subsidized homeownership but created hid- den costs to taxpayers and the economy. Elected officials of both parties pushed housing subsidies too far. CHRG-111shrg61513--10 Mr. Bernanke," Thank you. Chairman Dodd, Ranking Member Shelby, and other members of the Committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. I will begin today with some comments on the outlook for the economy and for monetary policy and then touch briefly on several important issues. Although the recession officially began more than 2 years ago, U.S. economic activity contracted particularly sharply following the intensification of the global financial crisis in the fall of 2008. Concerted efforts by the Federal Reserve, the Treasury Department, and other U.S. authorities to stabilize the financial system, together with highly stimulative monetary and fiscal policies, helped arrest the decline and are supporting a nascent economic recovery. Indeed, the U.S. economy expanded at about a 4-percent annual rate during the second half of last year. A significant portion of that growth, however, can be attributed to the progress that firms made in working down unwanted inventories of unsold goods, which left them more willing to increase production. As the impetus provided by the inventory cycle is temporary, and as the fiscal support for economic growth likely will diminish later this year, a sustained recovery will depend on continued growth in private sector final demand for goods and services. Private final demand does seem to be growing at a moderate pace, buoyed in part by a general improvement in financial conditions. In particular, consumer spending has recently picked up, reflecting gains in real disposable income and household wealth and tentative signs of stabilization in the labor market. Business investment in equipment and software has risen significantly. And international trade--supported by a recovery in the economies of many of our trading partners--is rebounding from its deep contraction of a year ago. However, starts of single-family homes, which rose noticeably this past spring, have recently been roughly flat, and commercial construction is declining sharply, reflecting poor fundamentals and continued difficulty in obtaining financing. The job market has been especially hard hit by the recession, as employers reacted to sharp sales declines and concerns about credit availability by deeply cutting their workforces in late 2008 and in 2009. Some recent indicators suggest that the deterioration in the labor market is abating: Job losses have slowed considerably, and the number of full-time jobs in manufacturing rose modestly in January. Initial claims for unemployment insurance have continued to trend lower, and the temporary services industry, often considered a bellwether for the employment outlook, has been expanding steadily since October. Notwithstanding these positive signs, the job market remains quite weak, with the unemployment rate near 10 percent and job openings scarce. Of particular concern, because of its long-term implications for workers' skills and wages, is the increasing incidence of long-term unemployment; indeed, more than 40 percent of the unemployed have been out of work for 6 months or more, nearly double the share of a year ago. Increases in energy prices resulted in a pickup in consumer price inflation in the second half of last year, but oil prices have flattened out over recent months, and most indicators suggest that inflation will likely remain subdued for some time. Slack in labor and product markets has reduced wage and price pressures in most markets, and sharp increases in productivity have further reduced producers' unit labor costs. The cost of shelter, which receives a heavy weight in consumer price indexes, is rising very slowly, reflecting high vacancy rates. In addition, according to most measures, longer-term inflation expectations have remained relatively stable. The improvement in financial markets that began last spring continues. Conditions in short-term funding markets have returned to near pre-crisis levels. Many (mostly larger) firms have been able to issue corporate bonds or new equity and do not seem to be hampered by a lack of credit. In contrast, bank lending continues to contract, reflecting both tightened lending standards and weak demand for credit amid uncertain economic prospects. In conjunction with the January meeting of the FOMC, Board members and Reserve Bank presidents prepared projections for economic growth, unemployment, and inflation for the years 2010 through 2012 and over the longer run. The contours of these forecasts are broadly similar to those I reported to the Congress last July. FOMC participants continue to anticipate a moderate pace of economic recovery, with economic growth of roughly 3 to 3 \1/2\ percent in 2010 and 3 \1/2\ to 4 \1/2\ percent in 2011. Consistent with moderate economic growth, participants expect the unemployment rate to decline only slowly, to a range of roughly 6 \1/2\ to 7 \1/2\ percent by the end of 2012, still well above their estimate of the long-run sustainable rate of about 5 percent. Inflation is expected to remain subdued, with consumer prices rising at rates between 1 and 2 percent in 2010 through 2012. In the longer term, inflation is expected to be between 1 \3/4\ and 2 percent, the range that most FOMC participants judge to be consistent with the Federal Reserve's dual mandate of price stability and maximum employment. Over the past year, the Federal Reserve has employed a wide array of tools to promote economic recovery and preserve price stability. The target for the Federal funds rate has been maintained at a historically low range of 0 to \1/4\ percent since December 2008. The FOMC continues to anticipate that economic conditions--including low rates of resource utilization, subdued inflation trends, and stable inflation expectations--are likely to warrant exceptionally low levels of the Federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. We have been gradually slowing the pace of these purchases in order to promote a smooth transition in markets and anticipate that these transactions will be completed by the end of March. The FOMC will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets. In response to the substantial improvements in the functioning of most financial markets, the Federal Reserve is winding down the special liquidity facilities it created during the crisis. On February 1, a number of these facilities, including credit facilities for primary dealers, lending programs intended to help stabilize money market mutual funds and the commercial paper market, and temporary liquidity swap lines with foreign central banks, were all allowed to expire. The only remaining lending program for multiple borrowers created under the Federal Reserve's emergency authorities, is the Term Asset-Backed Securities Loan Facility, or TALF, and it is scheduled to close on March 31 for loans backed by all types of collateral except for newly issued commercial mortgage-backed securities, and it will close on June 30 for loans backed by newly issued CMBS. In addition to closing its special facilities, the Federal Reserve is normalizing its lending to commercial banks through the discount window. The final auction of discount window funds to depositories through the Term Auction Facility, which was created in the early stages of the crisis to improve the liquidity of the banking system, will occur on March 8. Last week, we announced the maximum term of discount window loans, which was increased to as much as 90 days during the crisis, would be returned to overnight for most banks, as it was before the crisis erupted in August 2007. To discourage banks from relying on the discount window rather than private funding markets for short-term credit, last week we also increased the discount rate by 25 basis points, raising the spread between the discount rate and the top of the target range for the Federal funds rate to 50 basis points. These changes, like the closure of most of the special lending facilities earlier this month, are in response to the improved functioning of financial markets, which has reduced the need for extraordinary assistance from the Federal Reserve. These adjustments are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for monetary policy, which remains about the same as it was at the time of the January meeting of the FOMC. Although the Federal funds rate is likely to remain exceptionally low for an extended period, as the expansion matures, the Federal Reserve will at some point need to begin to tighten monetary conditions to prevent the development of inflationary pressures. Notwithstanding the substantial increase in the size of its balance sheet associated with its purchases of Treasury and agency securities, we are confident that we have the tools we need to firm the stance of monetary policy at the appropriate time. Most importantly, in October 2008 the Congress gave statutory authority to the Federal Reserve to pay interest on banks' holdings of reserve balances at Federal Reserve banks. By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates. Actual and prospective increases in short-term interest rates will be reflected in turn in longer-term interest rates and in financial conditions more generally. The Federal Reserve has also been developing a number of additional tools to reduce the large quantity of reserves held by the banking system, which will improve the Federal Reserve's control of financial conditions by leading to a tighter relationship between the interest rate paid on reserves and other short-term interest rates. Notably, our operational capacity for conducting reverse repurchase agreements, a tool that the Federal Reserve has historically used to absorb reserves from the banking system, is being expanded so that such transactions can be used to absorb large quantities of reserves. The Federal Reserve is also currently refining plans for a term deposit facility that could convert a portion of depository institutions' holdings of reserve balances into deposits that are less liquid and could not be used to meet reserve requirements. In addition, the FOMC has the option of redeeming or selling securities as a means of reducing outstanding bank reserves and applying monetary restraint. Of course, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments. I provided more discussion of these options and possible sequencing in a recent testimony. The Federal Reserve is committed to ensuring that the Congress and the public have all the information needed to understand our decisions and to be assured of the integrity of our operations. Indeed, on matters related to the conduct of monetary policy, the Federal Reserve is already one of the most transparent central banks in the world, providing detailed records and explanations of its decisions. Over the past year, the Federal Reserve also took a number of steps to enhance the transparency of its special credit and liquidity facilities, including the provision of regular, extensive reports to the Congress and the public; and we have worked closely with the GAO, the SIGTARP, the Congress, and private sector auditors on a range of matters relating to these facilities. While the emergency credit and liquidity facilities were important tools for implementing monetary policy during the crisis, we understand that the unusual nature of those facilities creates a special obligation to assure the Congress and the public of the integrity of their operation. Accordingly, we would welcome a review by the GAO of the Federal Reserve's management of all facilities created under emergency authorities. In particular, we would support legislation authorizing the GAO to audit the operational integrity, collateral policies, use of third-party contractors, accounting, financial reporting, and internal controls of these special liquidity and credit facilities. The Federal Reserve will, of course, cooperate fully and actively in all reviews. We are also prepared to support legislation that would require the release of the identities of the firms that participated in each special facility after an appropriate delay. It is important that the release occur after a lag that is sufficiently long that investors will not view an institution's use of one of these facilities as a possible indication of ongoing financial problems, thereby undermining market confidence in the institution or discouraging use of any future facility that might become necessary to protect the U.S. economy. An appropriate delay would also allow firms adequate time to inform investors through annual reports and other public documents of their use of Federal Reserve facilities. Looking ahead, we will continue to work with the Congress in identifying approaches for enhancing the Federal Reserve's transparency that are consistent with our statutory objectives of fostering maximum employment and price stability. In particular, it is vital that the conduct of monetary policy continue to be insulated from short-term political pressures so that the FOMC can make policy decisions in the longer-term economic interests of the American people. Moreover, the confidentiality of discount window lending to individual depository institutions must be maintained so that the Federal Reserve continues to have effective ways to provide liquidity to depository institutions under circumstances where other sources of funding are not available. The Federal Reserve's ability to inject liquidity into the financial system is critical for preserving financial stability and for supporting depositories' key role in meeting the ongoing credit needs of firms and households. Strengthening our financial regulatory system is essential for the long-term economic stability of the Nation. Among the lessons of the crisis are the crucial importance of macroprudential regulation that is, regulation and supervision aimed at addressing risks to the financial system as a whole--and the need for effective consolidated supervision of every financial institution that is so large or interconnected that its failure could threaten the functioning of the entire financial system. The Federal Reserve strongly supports the Congress' ongoing efforts to achieve comprehensive financial reform. In the meantime, to strengthen the Federal Reserve's oversight of banking organizations, we have been conducting an intensive self-examination of our regulatory and supervisory responsibilities and have been actively implementing improvements. For example, the Federal Reserve has been playing a key role in international efforts to toughen capital and liquidity requirements for financial institutions, particularly systemically critical firms, and we have been taking the lead in ensuring that compensation structures at banking organizations provide appropriate incentives without encouraging excessive risk taking. The Federal Reserve is also making fundamental changes in its supervision of large, complex bank holding companies, both to improve the effectiveness of consolidated supervision and to incorporate a macroprudential perspective that goes beyond the traditional focus on safety and soundness of individual institutions. We are overhauling our supervisory framework and procedures to improve coordination within our own supervisory staff and with other supervisory agencies and to facilitate more integrated assessments of risks within each holding company and across groups of companies. Last spring the Federal Reserve led the successful Supervisory Capital Assessment Program, popularly known as the bank stress tests. An important lesson of that program was that combining onsite bank examinations with a suite of quantitative and analytical tools can greatly improve comparability of the results and better identify potential risks. In that spirit, the Federal Reserve is also in the process of developing an enhanced quantitative surveillance program for large bank holding companies. Supervisory information will be combined with firm-level, market-based indicators and aggregate economic data to provide a more complete picture of the risks facing these institutions and the broader financial system. Making use of the Federal Reserve's unparalleled breadth of expertise, this program will apply a multidisciplinary approach that involves economists, specialists in particular financial markets, payments systems experts, and other professionals, as well as bank supervisors. The recent crisis has also underscored the extent to which direct involvement in the oversight of banks and bank holding companies contributes to the Federal Reserve's effectiveness in carrying out its responsibilities as a central bank, including the making of monetary policy and the management of the discount window. But most important, as the crisis has once again demonstrated, the Federal Reserve's ability to identify and address diverse and hard-to-predict threats to financial stability depends critically on the information, expertise, and powers that it has by virtue of being both a bank supervisor and a central bank. The Federal Reserve continues to demonstrate its commitment to strengthening consumer protections in the financial services arena. Since the time of the previous Monetary Policy Report in July, the Federal Reserve has proposed a comprehensive overhaul of the regulations governing consumer mortgage transactions, and we are collaborating with the Department of Housing and Urban Development to assess how we might further increase transparency in the mortgage process. We have issued rules implementing enhanced consumer protections for credit card accounts and private student loans as well as new rules to ensure that consumers have meaningful opportunities to avoid overdraft fees. In addition, the Federal Reserve has implemented an expanded consumer compliance supervision program for nonbank subsidiaries of bank holding companies and foreign banking organizations. More generally, the Federal Reserve is committed to doing all that can be done to ensure that our economy is never again devastated by a financial collapse. We look forward to working with the Congress to develop effective and comprehensive reform of the financial regulatory framework. Thank you. Senator Johnson. [Presiding.] Thank you, Mr. Chairman. Is there an agreement that 5 minutes should be enough on the clock? I do not want to be overly rigid, but so be it. Chairman Bernanke, the weather has been unusually harsh across the country in the past month. This has disrupted business and Government activity and is likely to have an impact on employment. Do you think the effects will be strong enough to show up in the next month's employment statistics? " CHRG-110shrg50420--9 Mr. Dodaro," First, as it relates to the authorities under the Economic Stabilization Act for the Secretary of Treasury, we believe that that legislation is worded broadly enough that it would permit the Secretary of Treasury to provide the assistance using TARP funds. And the Secretary has broad discretion to set whatever conditions on the assistance that he would determine necessary. I would comment, though, that in my opinion, if TARP money is used, there needs to be still additional changes in the board oversight structure. Senator Shelby mentioned our recent report on the TARP program where we pointed out the fact that there are many critical management issues that are not yet addressed as part of that oversight over that program. " FOMC20080130meeting--311 309,MS. DANKER.," Yes. The vote is on the language for alternative B as it is in the Bluebook and in Brian's handout and on the directive from the Bluebook, which I will read. ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 3 percent."" Chairman Bernanke Vice Chairman Geithner President Fisher Governor Kohn Governor Kroszner Governor Mishkin President Pianalto President Plosser President Stern Governor Warsh Yes Yes No Yes Yes Yes Yes Yes Yes Yes " FOMC20071206confcall--11 9,MR. SHEETS.," In conjunction with the establishment of the TAF, the staff proposes that the FOMC authorize a temporary reciprocal currency arrangement with the European Central Bank. This facility, which the ECB has requested, would provide it with greater scope to issue dollar credit to euro-area banks. The proposal is for a liquidity swap arrangement that would allow the ECB access to a cumulative total of $20 billion outstanding, in tranches of up to $10 billion each, at any time over the life of the arrangement. The swap facility would expire after six months unless renewed. The purchase of U.S. dollars with foreign currency would be based on the prevailing spot exchange rate, and the ECB would pay interest on the foreign currency held by the Federal Reserve. There is some possibility that the Swiss National Bank may request a similar, albeit smaller, swap facility. This temporary arrangement with the ECB is proposed to allow dollar funding problems now faced by European banks, particularly at terms longer than overnight, to be addressed more directly by their home central bank. Improved conditions in European dollar trading would guard against the spillover of volatility in such trading to New York trading and could help reduce term funding pressures in U.S. markets. In addition, these measures may help address the difficulties in the foreign exchange swap market, which Bill has discussed. Establishment of this liquidity swap line, along with the TAF, could have positive confidence effects. Moreover, given the strong financial position of the ECB, the swap line would involve virtually no credit risk to the Federal Reserve. By providing dollars to the ECB to use in its efforts to address term dollar funding problems in Europe, we would assist credit markets without ourselves providing funding to banks overseas. Sandy Krieger will now continue our presentation." CHRG-111shrg50814--141 Chairman Dodd," Well, we need to stay closely in touch with you on that because that will be part of it. The second question I have has to do with, over the years, the Fed has not been active as a public trader in Treasury notes. In fact, it has been decades, I guess you could say, going back maybe to the very time that you are talking about historically, preferring instead to use the short-term Fed funds rate to manage interest rates. With the Fed's target interest rate basically at zero, you have been forced to consider other means of conducting monetary policy. In December, the FOMC said it was, and I quote, ``evaluating the benefits of purchasing long-term Treasury securities.'' In January, FOMC said it is now prepared to do this if, quote, ``evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private sector markets.'' Can you be more specific about those conditions that would lead the Federal Reserve to purchase long-term Treasury securities? " CHRG-111hhrg48674--17 Mr. Bachus," Mr. Chairman, in my opening statement I said that we should not enter into arrangements with financial institutions if the terms and conditions of those agreements cannot be fully disclosed. Would you like to react to that? " FOMC20080318meeting--93 91,MR. MISHKIN.," Wouldn't you like to know! I believe that actually the Greenbook forecast of a mild recession is reasonable, but the possibility that we could have a severe recession is uncomfortably high, and I find the prospect pretty scary. The reality is that we are in this adverse feedback loop that I and others talked about. I think we're deep into it. The credit markets have been deteriorating. That's led to a sharp weakening of the economy's prospects. This is reflected in the very large change in the Greenbook forecast, with which I do strongly concur, so I don't think that it was out of line to put those in. Of course, that weakening has been feeding back to deteriorating financial conditions. So I think we're really in a tough pickle, and there are costs not just in terms of the economy. One result is that we've just expanded the safety net to a much wider set of institutions, and we are in a brave new world here, and it is very disturbing. So the ramifications in terms of the economy weakening and the adverse feedback loop go beyond just the fact that we might have unemployment. It may have major effects on the way markets work in the future, and that, I think, is something that we should be worried about and should be a consideration as well. The bottom line on real activity for me is that the prospects are very poor, and I find the downside risk just plain scary. That's the first part of my depression. The second part of the depression is that it's bad enough that we had these contractionary aggregate demand shocks from the financial sector, but we also have had very negative supply shocks that are both contractionary and inflationary. So we are getting hit by the double whammy. The news on inflation has generally not been good, even with the recent CPI numbers. But then, of course, they are reversed by the PPI numbers today. I don't put that much weight on the actual current numbers because, as you know, I take a view that the primary drivers of inflation and inflation dynamics are inflation expectations and expectations about future output gaps. So that's the framework in which I'd like to discuss what will happen on the inflation front. We have two problems in terms of inflation expectations right now. One is the supply shock, which I think is having some effects on inflation expectations, and also the view--although I believe it's incorrect, I do think that there's a problem that this view is widely held outside, and President Plosser mentioned this--that we on the FOMC are focused only on growth and are not at all worried about inflation. This is a communication issue that is hard to deal with because, even though I've been advocating being more aggressive in terms of easing, I do worry very much about the issue that we also have to indicate that, if necessary, we'll get out the baseball bat to keep inflation under control. That is not an easy thing to do. So when I look at inflation expectations, which I consider to be a key driver of inflation, I think that the evidence in the data is that we have had not a big increase but a slight increase in inflation expectations, on the order of about 10 basis points. There's a lot of uncertainty about that; it could be a little more than that, but I don't think a whole lot more. Also disturbing is that we certainly have had a big increase in long-run inflation uncertainty. That's reflected not only in terms of inflation compensation but also in the fact that people are buying inflation caps, TIPS are becoming very popular, and so forth and so on. In fact, one of the negative things that happened to me as a result of taking this job is that I had my entire TIAA-CREF in TIPS and unfortunately I had to divest all of it because they are government securities, and that turned out to be bad. But that's only one of the minor costs of being in this position. [Laughter] The issue here is that, although I don't think that inflation expectations have gotten unhinged at this point--and I think that we can say that the phrase ""reasonably well contained"" is okay--there is a greater risk that they could get unhinged. Now, I want to be clear. I'm not talking about the 1970s. It's not ""That '70s Show."" I have not been particularly happy with Allan Meltzer's comments about a bunch of things. The issue here is not that inflation expectations would go to that kind of level, but it could be that inflation expectations go up to 2� or maybe even a little higher and it would be costly to get that down. That's the concern we have to worry about. But let me talk about the other side because, when I think about the inflation dynamics, it's not just inflation expectations. I do not believe in the deus ex machina view of the inflation process. Something has to tie things down, and what ties it down is not current output gaps--which is why I think the standard Phillips curves don't predict very well--but expectations about future output gaps. On that score, I worry that there could be a lot of downside risk to inflation from that. If really bad things happen, which I think unfortunately is a seriously possibility, inflation could fall. A key fact, by the way, is that if you look at past recessions, you do find that inflation falls in the 12 months after recessions. In a couple of cases with supply shocks, there was a rise in inflation at the beginning of the recessions. Seven out of eight are in that category. Particularly if it's a severe recession, it's much more likely for inflation to fall. So it's not true that there's just upside risk; there is downside risk as well, and that's one reason that inflation uncertainty is not an issue just of potential upside. In fact, in the 2003 episode that President Lacker mentioned, the reason there was such a sharp rise in inflation compensation was not that people worried about inflation going up but that they worried that inflation would go down. Nonetheless, there's still a cost to the fact that longrun inflation expectations are not as solidly grounded as they were before. So my view in general is that we are facing an incredibly unpleasant tradeoff. We basically have the risk of the economy turning very sharply and the risk of inflation getting somewhat unhinged. I want to discuss that later. I wasn't going to discuss this, but I just really can't not react to the comments that you made, President Fisher. There's a view out there in the media that monetary policy has been ineffective. This was the statement that I think you made, and I think it is just plain wrong. So I want to discuss it because it's actually really important in thinking about a policy stance right now, and it's important to think about the economics of this. We have had a very nasty set of contractionary shocks from the financial sector, particularly the widening of credit spreads and the restriction of credit. So I want us to think about a counterfactual. Let's think about a situation in which we had what's happened and we did not lower interest rates. What would have been the outcome? Do you think that credit spreads would have lowered? I think credit spreads would have risen. In fact, when you think about what credit spreads are being driven by--I've argued this before--there's a valuation risk--the fact that we can't value assets, and that's this price discovery problem that we really can't do that much about. But there is also a macroeconomic risk, which is a lot of what's going on right now, particularly in terms of the housing market where people don't know where housing prices are going to bottom out. The view that they may keep on going down--and we had a very negative number on housing prices recently--means that even the AAA tranches now look as though they're very vulnerable, and therefore, the credit spreads on them go up a whole lot. My view is that monetary policy has been very effective because things would be much, much worse if we hadn't eased. On the other hand, we just had an incredibly nasty set of shocks as a result of what you described were the problems in these sectors. So I really think that this is very important. To finish up on this, the example of Japan is constructive because the Bank of Japan had a view very similar to the one that you've expressed, which is that they had all these problems in the banking sector, and the problems were not their fault. But they then took the view that they couldn't do anything about it. Monetary policy was not the source of the weak economy, so they were very slow to lower interest rates. The Chairman has talked about this. Every monetary economist who went to the Bank of Japan during this period--I did it when I was with the New York Fed in the mid-1990s--told them that their monetary policy was too tight. They basically said, ""Well, you know, it's not too tight, and it's not our fault that the banks are all screwed up because of poor regulation."" Well, the result was they ended up with deflation, and they lost ten years of growth. I'm being a little more blunt than usual, but I think that the economic arguments here are actually central in our discussion. " CHRG-111hhrg50289--86 Mr. Watters," Good afternoon, Chairman Velazquez, Ranking Member Graves, and other distinguished members of the panel. We are a family owned business headquartered in Piscataway, New Jersey. We sell, rent and service construction equipment. We represent about ten different manufacturers, including Case, Terex, Grove, Manitowoc and Doosan. We employ about 75 people from five locations in New York and New Jersey. And just as an aside, Madam Chairwoman, our service territory includes the 12th Congressional District of New York. We also have an export department, and about 20 percent of our volume is export related of U.S. equipment and parts. As you mentioned, I serve on the AED board. AED is a national association of authorized independent distributors for construction, mining, forestry, and agricultural equipment, and the vast majority of AED's members are small, locally owned family businesses such as mine. There are three ways the current credit crisis is hurting our industry. First is that as a distributor, my own cost of borrowing is increasing and in some cases credit may even be unavailable. Access to capital is critical to our industry. Distributors such as myself borrow money to finance equipment in our inventories and rental fleets and to operate our companies on a day-to-day basis. We generally utilize large banks and finance companies as sources for this lending. Continued access to credit from sources such as these is absolutely necessary for our industry to exist, and the current crisis has made it difficult, increasingly difficult for dealers such as myself to find this capital. The second way the crisis has hurt our industry is that our customers and the developers they work for cannot find financing for their jobs. You are all well aware of the current condition of the residential construction market. Essentially it is dead, and the commercial construction is slowing as well. Since developers cannot finance their projects, our customers have no work and so need no machinery, and we therefore have no business. The lack of credit creates a chain of events, painful events, I might add, that ultimately lead to decreased business and employment throughout our entire industry. The third way the credit crisis has impacted our industry is that we are unable to finance our customer's retail transactions. Contractors themselves rely heavily on credit when purchasing equipment. The most common sources of credit here again are finance companies and banks. These banks and finance companies have made access to their credit resources unavailable or, in the rare case when they are willing to finance a transaction, exceedingly expensive. So the net result is if we as a distributor are lucky enough to find a customer that has work and is actually willing to purchase a new machine, we then have difficult to finding him financing to make that transaction possible. In April, AED conducted a member survey to clarify what impact the credit crisis was having on our industry. The findings paint an ugly picture. Eighty-one percent of our respondents reported they had lost sales in the last year because qualified purchasers had been unable to get financing. Fifty-six percent of distributors reported increase in their own credit costs, and 44 percent of respondents said their companies had difficulty security credit. The findings illustrate that the lack of access to capital is undermining equipment markets and increasing the cost of doing business for equipment distributors. The impact of all of this on our markets has been staggering. In some regions of the country the market for new equipment sales has fallen by as much as 85 percent from peak levels in 2006. Our own company has experienced sales this year less than 50 percent of what we sold just last year. We have responded to this drop in business volume with layoffs and cutbacks of every type we can make, and we are still hanging on just hoping to survive this mess. Having said all of this, I think there are some things that Congress and the executive branch can do to help ease our pain. First, Congress should put new multi-year authorization laws in place for federal highway, sewer and drinking water infrastructure programs and dramatically increase investment in these areas. We need to create infrastructure construction activity. Investing in our infrastructure speeds economic recovery, will help address the staggering 19 percent unemployment rate in construction workers and restore lending confidence in our industry. This will also create demand for the thousands of products that are consumed on a typical construction project, including equipment sold by firms such as mine. Second, the SBA should be directed to work with finance companies and banks serving our industry to develop loan products that meet our unique needs. SBA should also reexamine its size standards to determine whether they are preventing companies that otherwise fit the definition of small business from benefitting from SBA programs. Once construction is reached and programs are in place, SBA should be encouraged to undertake aggressive outreach to lenders, contractors and distributors. And finally, and I will go quick, Congress and the executive branch should continue to work to improve access to capital for the finest companies that serve all American industry because in spite of what the banks were saying earlier, which they are continuing to lend at previous rates, that is not what we are seeing from the business side of things. Thank you. [The prepared statement of Mr. Watters is included in the appendix.] " FOMC20071211meeting--100 98,MR. LOCKHART.," Thank you, Mr. Chairman. I think President Stern framed it well in bringing focus to the effect on our thinking that the financial markets are having. As many have said, the central question is not whether the economy is softening but whether it is softening beyond the range that underpinned the policy decision in October. I’d add to that a range of questions related to financial markets, particularly the question of whether the deterioration in the financial markets changes the prospects for achieving financial stability, the potential for spreading to a wider array of financial markets and institutions, the potential for spillover to the general economy, and the compounding of the already heightened degree of uncertainty. All of these weigh heavily on my thinking. Like the Greenbook projections, Atlanta’s forecast has been revised down as a result of incoming data since the last meeting. I just point out, speaking only for ourselves, that these downward revisions of previous forecasts and our general outlook have been a pattern over recent months. The current situation is extremely difficult to read—which is another way of saying that uncertainty around our forecast has increased yet again. Contributing to this uncertainty is the continuing, if not accelerating, gap between the anecdotal information and the views I’ve received from Wall Street versus Main Street. The expectations of financial market participants have deteriorated and can be characterized as extremely serious. However, the message I get from directors and representatives of nonfinancial businesses outside the housing sector, though relatively pessimistic, has not changed substantially since our October meeting. In my conversations with financial market contacts, to varying degrees I heard the persistent and growing apprehension concerning the spread of turmoil to an expanding set of affected markets and institutions and a wondering of what will be the next shoe to drop. One consistent message is the belief that the recent volatility and increase in term spreads cannot be entirely explained by the year-end problem. Most of my contacts agreed that year-end balance sheet concerns are adding to market stress, but no one expressed confidence that getting past year-end will bring much reduction of concerns over counterparty weakness, asset values, and secondary market liquidity. Most expect financial market turmoil to be protracted, with increasing risk to the general economy. Almost all my contacts noted that deteriorating housing values are a root cause, feeding problems in the markets. This view holds that the adjustment in prices and inventory required to stabilize the housing sector will take many months to play out, and until that occurs, the value of structured financial instruments and the solvency and liquidity of structured investment vehicles will be uncertain. There remains a great deal of skepticism that arrangements like the super SIV and the Treasury’s rate freeze plan will have much tangible effect. The issue of SIV restructuring and support by sponsors is a growing focus of concern because of their linkage to money market funds as well as their contribution to a general contraction of credit availability. In sum, my contacts in the financial industry uniformly express the belief that things will not get better any time soon and may well get worse. While recognizing that a rate reduction does not directly address the information problems in the markets, there is widespread sentiment that lower costs of funds will help. Turning to the anecdotal inputs from contacts in my District, there is some divergence of views between contacts directly affected by the housing sector, including bankers, and others. Bank loan activity remains particularly weak in real estate segments. Trucking, large retailers, auto dealerships, and businesses supplying building materials and household durables were identified as segments where loan volumes are slipping. Industrial warehouse markets have weakened in some metro areas as subcontractors have exited. Bankers also expect that consumer credit exposures in credit cards, auto loans, prime mortgages, and HELOCs will see a combination of credit deterioration and demand contraction in 2008. The anecdotal messages from other contacts are less dire. We took great care in our information-gathering this round to probe hiring expectations, investment plans, and credit availability conditions. Though credit conditions do seem to have tightened, we still are not hearing that they are preventing planned spending. Spending and hiring plans remain on the weak side, but no more so than was the case at our October meeting. Consistent with the Greenbook projection for exports, we heard that spending from abroad, including international tourism and condo-purchase activity, continues relatively strong. At the branch board meeting in Miami, I heard that Russians are the latest foreign buyers of condos. So combine that with President Poole’s comment on trucks, as a child of the Cold War, I think it is very ironic that our bailout is coming from the Russians. [Laughter] On the employment front, the demand for workers in sectors such as hospitality and energy remains quite strong, but overall plans appear to be more cautious. The trend in regional labor data mirrors the slowing trend in the national statistics. Each FOMC round my staff provides a summary sentiment index of expected economic conditions over the next six months based on responses of directors and contacts. Relative to the October meeting, that index is little changed, with the majority expecting flat or slower growth. When I combine the somewhat, but not dramatically, worse data inputs since the last meeting with the anecdotal and survey information from regional and other markets, I’m left with a view that economic fundamentals, current and prospective, have not yet fallen off a cliff. That being said, there’s not much of a case to be made for any risk assessment other than one weighted to the downside. In my view, the potential for protracted and growing financial market troubles should weigh heavily in the policy decision, and though recent core inflation readings are acceptable, I continue to be concerned about the ongoing divergence between headline and core inflation. Until they converge, price pressures cannot be removed from the watch list. But overall I see more uncertainty and, therefore, more downside risk in the real economic growth picture. Thank you, Mr. Chairman." FOMC20080310confcall--10 8,MR. ALVAREZ.," That is right. We are relying on market conditions, on limiting it to primary dealers, and on limiting the types of assets that we will accept as collateral. " CHRG-111hhrg58044--310 CENTER Ms. Wu. Mr. Chairman, Representative Hensarling, and members of the subcommittee, thank you very much for inviting me here today. I am testifying on behalf of the low-income clients of the National Consumer Law Center. And, Mr. Chairman, thank you for holding this hearing about the use of credit reports in areas beyond lending, such as employment and insurance. And we also thank you for inviting us to speak about the need to fix a scrivener's error in the Fair Credit Reporting Act. The use of credit reports in employment is a growing practice, with nearly half of employers involved in it. It's a practice that is harmful and unfair to American workers. For that reason, we strongly support H.R. 3149, and we thank Chairman Gutierrez and Congressman Steve Cohen for introducing it. This bill would restrict the use of credit reports in employment to only those positions for which it is truly warranted, such as those requiring national security or FDIC-mandated clearance. We oppose the unfettered use of credit histories and support H.R. 3149 for a number of reasons. The first and foremost is the profound absurdity of the practice. Considering credit histories in hiring creates a vicious Catch-22 for job applicants. A worker loses her job, and is likely to fall behind on her bills due to lack of income. She can't rebuild her credit history if she doesn't have a job, and she can't get a job if she has bad credit. Commentators have called this a financial death spiral, as unemployment leads to worse credit records, which, in turn, make it harder for the worker to get a job. Second, the use of credit histories in hiring discriminates against African-American and Latino job applicants. We have heard how study after study has documented, as a group, these groups have lower credit scores, including the FTC study that did find the disparities in credit scoring. These are groups that have been disproportionately affected by predatory credit practices, such as the marketing of subprime mortgages and auto loans and, as a result, have suffered higher foreclosure rates, all of which have damaged their credit histories. The Equal Employment Opportunity Commission has expressed concerns over the use of credit histories in employment, and recently sued one company over the practice. Third, there is no evidence that credit history predicts job performance. The sole study on this issue has concluded there isn't even a correlation. Even industry representatives have admitted, ``At this point we don't have any research to show any statistical correlation between what's in somebody's credit report and their job performance, or likelihood to commit fraud.'' Finally, as we have testified here before, the consumer reporting system suffers from high rates of inaccuracy, rates that are unacceptable for purposes as important as employment. And the estimates range from 3 percent, which is the industry estimate, to 12 percent, from the FTC studies, to 37 percent in an online survey. In an environment with 10 percent unemployment, a 3 percent error rate in credit reports affects 6 million American workers, and it's not acceptable. And, remember, a consumer who has an error in her credit report, and is able to fix it--which is very difficult--can reapply for credit. But very few employers are going to voluntarily hold up a hiring process for one or more months to allow an applicant to correct an error in the credit report. The issue at stake is whether workers are fairly judged on their ability to perform a job, or whether they're discriminated against because of their credit history. Oregon recently signed a bill into law restricting this practice. Other States are considering it, and Congress should do the same and pass H.R. 3149. The second issue I want to talk about is a scrivener's error. The amendments of 2003 may have inadvertently deprived consumers of a 30-year-old pre-existing right they had to enforce the FCRA's adverse action notice requirement. This is the notice given when credit or insurance or employment is denied, based on an unfavorable credit report. That was intended to limit the remedies for a totally new notice--the risk-based pricing notice--at 1681m(h). However, due to ambiguous drafting, a number of courts have interpreted this limitation to apply to the entirety of section 1681m of the FCRA, including the pre-existing adverse action notice. Congress can easily and should fix the scrivener's error, because it was never part of the legislative bargain struck by FACTA. In fact, FACTA's legislative history indicates that Congress had absolutely no intention of abolishing any private enforcement of the adverse action notice requirement, and an uncodified section specifically states that nothing in FACTA ``shall be construed to affect any liability under section 616 or 617 of the Fair Credit Reporting Act''--that is the private enforcement provisions--``that existed on the day before the date of the enactment of this act.'' And there is more evidence that Congress didn't intentionally abolish the private enforcement. If it had done so, the banking and credit industry would have trumpeted that change. In fact, the industry has never made that claim, with only the American Banker noting that FACTA perhaps inadvertently eliminated the existing right of consumers and State officials to sue for violations of the adverse action provisions. Even 4 years later, in a hearing before the full committee, my fellow testifiers today declined to claim that FACTA had intentionally abolished this private remedy. Now, despite the clear legislative history, several dozen courts have, unfortunately, held that FACTA abolished this private remedy, depriving hundreds of consumers of their rights. We think that the documented cases are perhaps only the tip of the iceberg, so we assume that customers' damage has-- " FOMC20060328meeting--237 235,MR. STERN.," Thank you, Mr. Chairman. Let me just comment on a few things. First of all, I support increasing the federal funds rate another ¼ percentage point today. I think that’s consistent with the Greenbook forecast, with which I’m comfortable, and it’s clearly what market participants expect. And I don’t think this is a time when we want to surprise market participants. In thinking about policy strategy going forward, I guess what interests me the most, and concerns me the most, is June rather than May. There’s a high likelihood, and clearly the markets expect, that we will be moving again in May. But I think it’s important that we try to get ourselves some more flexibility and some more wiggle room come June. So I think exactly what we say and how we say it are going to matter here. Having said that, it’s not easy to have a big impact, it seems to me, on what people might expect for June without going further than I feel comfortable in saying that we’re about to stop or we will stop after one more increase. I do think that it might help, at least on the margin, to adopt paragraph 5 from alternative A for the reasons that Vincent pointed out. Getting people to focus more on the data and less on what we may think about it would be helpful. The only other thing I would add is—and I realize I’m in the minority on this—that I’m not altogether comfortable with this constant reference to resource utilization. As you know, I’m not a big fan of the NAIRU concept. I’m not comfortable with the empirical work there, and I take President Fisher’s point that in an increasingly global economy we need to be a little careful about thinking too narrowly about this." FOMC20080430meeting--208 206,MS. DANKER.," This vote encompasses the language of alternative B in the table that was handed out as part of Bill's briefing yesterday, as well as the directive from the Bluebook. ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 2 percent."" Chairman Bernanke Vice Chairman Geithner Yes Yes President Fisher Governor Kohn Governor Kroszner Governor Mishkin President Pianalto President Plosser President Stern Governor Warsh No Yes Yes Yes Yes No Yes Yes " FOMC20071211meeting--162 160,MS. DANKER.," The vote today encompasses the directive from the Bluebook and the language of alternative B that was in the Bluebook and in the handout. The directive reads as follows: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 4¼ percent.” Chairman Bernanke Yes Vice Chairman Geithner Yes President Evans Yes President Hoenig Yes Governor Kohn Yes Governor Kroszner Yes Governor Mishkin Yes President Poole Yes President Rosengren No Governor Warsh Yes" FOMC20051213meeting--138 136,MS. DANKER.," I’ll be reading the directive wording from the Bluebook and the assessment of risks from alternative B in exhibit 2 from Brian’s presentation. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 4¼ percent.” And the wording for the assessment of risks: “The Committee December 13, 2005 90 of 100 attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.”" CHRG-111hhrg56766--24 Mr. Bernanke," Thank you, Mr. Chairman. I will try not to abuse that. Chairman Frank, Ranking Member Bachus, and other members of the committee, I am pleased to present the Federal Reserve's semi-annual Monetary Policy Report to the Congress. I will begin today with some comments on the outlook for the economy and for monetary policy, then touch briefly on several other important issues. Although the recession officially began more than 2 years ago, U.S. economic activity contracted particularly sharply following the intensification of the global financial crisis in the fall of 2008. Concerted efforts by the Federal Reserve, the Treasury Department, and other U.S. authorities to stabilize the financial system, together with highly stimulative monetary and fiscal policies, helped arrest the decline and are supporting a nascent economic recovery. Indeed, the U.S. economy expanded at about a 4 percent annual rate during the second half of last year. A significant portion of that growth, however, can be attributed to the progress that firms have made in working down unwanted inventories of unsold goods, which have left them more willing to increase production. As the impetus provided by the inventory cycle is temporary, and as the fiscal support for economic growth will likely diminish later this year, a sustained recovery will depend on continued growth in private-sector final demand for goods and services. Private-sector final demand does seem to be growing at a moderate pace, buoyed in part by a general improvement in financial conditions. In particular, consumer spending has recently picked up, reflecting gains in real disposable income and household wealth and tentative signs of stabilization in the labor market. Business investment in equipment and software has risen significantly. And international trade--supported by a recovery in the economies of many of our trading partners--is rebounding from its deep contraction of a year ago. However, starts of single-family homes, which rose notably this past spring, have recently been roughly flat, and commercial construction is declining sharply, reflecting poor fundamentals and continued difficulty in obtaining financing. The job market has been hit especially hard by the recession, as employers reacted to sharp sales declines and concerns about credit availability by deeply cutting their workforces in late 2008 and in 2009. Some recent indicators suggest that the deterioration in the labor market is abating: Job losses have slowed considerably, and the number of full-time jobs in manufacturing rose modestly in January. Initial claims for unemployment insurance have continued to trend lower, and the temporary services industry, often considered a bellwether for the employment outlook, has been expanding steadily since October. Notwithstanding these positive signs, the job market remains quite weak, with the unemployment rate near 10 percent and job openings scarce. Of particular concern because of its long-term implications for worker's skills and wages, is the increasing incidence of long-term unemployment; indeed, more than 40 percent of the unemployed have been out of work for 6 months or more, nearly double the share of a year ago. Increases in energy prices resulted in a pick-up in consumer price inflation in the second half of last year, but oil prices have flattened out over recent months, and most indicators suggest that inflation likely will be subdued for some time. Slack in labor and product markets has reduced wage and price pressures in most markets, and sharp increases in productivity have further reduced producers' unit labor costs. The cost of shelter, which receives a heavy weight in consumer price indexes, is rising very slowly, reflecting high vacancy rates. In addition, according to most measures, longer-term inflation expectations have remained relatively stable. The improvement in financial markets that began last spring continues. Conditions in short-term funding markets have returned to near pre-crisis levels. Many (mostly larger) firms have been able to issue corporate bonds or new equity and do not seem to be hampered by a lack of credit. In contrast, bank lending continues to contract, reflecting both tightened lending standards and weak demand for credit amid uncertain economic prospects. In conjunction with the January meeting of the Federal Open Market Committee, Board members and Reserve Bank presidents prepared projections for economic growth, unemployment, and inflation for the years 2010 through 2012 and over the longer run. The contours of these forecasts are broadly similar to those I reported to the Congress last July. FOMC participants continue to anticipate a moderate pace of economic recovery, with economic growth of roughly 3 to 3\1/2\ percent in 2010 and 3\1/2\ to 4\1/2\ percent in 2011. Consistent with moderate economic growth, participants expect the unemployment rate to decline only slowly, to a range of roughly 6\1/2\ to 7\1/2\ percent by the end of 2012, still well above their estimate of the long-run sustainable rate of about 5 percent. Inflation is expected to remain subdued, with consumer prices rising at rates between 1 and 2 percent in 2010 through 2012. In the longer term, inflation is expected to be between 1\3/4\ and 2 percent, the range that most FOMC participants judge to be consistent with the Federal Reserve's dual mandate of price stability and maximum employment. Over the past year, the Federal Reserve has employed a wide array of tools to promote economic recovery and preserve price stability. The target for the Federal funds rate has been maintained at a historically low range of 0 to \1/4\ percent since December 2008. The FOMC continues to anticipate that economic conditions--including low rates of resource utilization, subdued inflation trends, and stable inflation expectations--are likely to warrant exceptionally low levels of the Federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. We have been gradually slowing the pace of these purchases in order to promote a smooth transition in markets and anticipate that these transactions will be completed by the end of March. The FOMC will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets. In response to the substantial improvements in the functioning of most financial markets, the Federal Reserve is winding down the special liquidity facilities created during the crisis. On February 1st, a number of these facilities, including credit facilities for primary dealers, lending programs intended to help stabilize money market mutual funds and the commercial paper market, and temporary liquidity swap lines with foreign central banks, were all allowed to expire. The only remaining lending program for multiple borrowers created under the Federal Reserve's emergency authorities, the Term Asset-Backed Securities Loan Facility or TALF, is scheduled to close on March 31st for loans backed by all types of collateral except newly issued commercial mortgage-backed securities (CMBS) and on June 30th, for loans backed by newly issued CMBS. In addition to closing its special facilities, the Federal Reserve is normalizing its lending to commercial banks through the discount window. The final auction of discount-window funds to depositories for the Term Auction Facility, which was created in the early stages of the crisis to improve the liquidity of the banking system, will occur on March 8th. Last week, we announced that the maximum term of discount window loans, which was increased to as much as 90 days during the crisis, would be returned to overnight for most banks, as it was before the crisis erupted in August 2007. To discourage banks from relying on the discount window rather than private funding markets for short-term credit, last week we also increased the discount rate by 25 basis points, raising the spread between the discount rate and the top of the target range for the Federal funds rate to 50 basis points. These changes, like the closure of most of the special lending facilities earlier this month, are in response to the improved functioning of financial markets, which has reduced the need for extraordinary assistance from the Federal Reserve. These adjustments are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for monetary policy, which remains about the same as it was at the time of the January meeting of the FOMC. Although the Federal funds rate is likely to remain exceptionally low for an extended period, as the expansion matures, the Federal Reserve will at some point need to begin to tighten monetary conditions to prevent the development of inflationary pressures. Notwithstanding the substantial increase in the size of its balance sheet associated with its purchases of Treasury and agency securities, we are confident that we have the tools we need to firm the stance of monetary policy at the appropriate time. Most importantly, in October 2008, the Congress gave statutory authority to the Federal Reserve to pay interest on banks' holdings of reserve balances at Federal Reserve banks. By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates. Actual and prospective increases in short-term interest rates will be reflected in longer-term interest rates and in financial conditions more generally. The Federal Reserve has also been developing a number of additional tools to reduce the large quantity of reserves held by the banking system, which will improve the Federal Reserve's control of financial conditions by leading to a tighter relationship between the interest rate paid on reserves and other short-term interest rates. Notably, our operational capacity for conducting reverse repurchase agreements, a tool that the Federal Reserve has historically used to absorb reserves from the banking system, is being expanded so that such transactions can be used to absorb large quantities of reserves. The Federal Reserve is also currently refining plans for a term deposit facility that could convert a portion of depository institutions' holdings reserve balances into deposits that are less liquid and cannot be used to meet reserve requirements. In addition, the FOMC has the option of redeeming or selling securities as a means of reducing outstanding bank reserves and applying monetary restraint. Of course, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments. I have provided more discussion of these options and possible sequencing in a recent testimony. The Federal Reserve is committed to ensuring that the Congress and the public have all the information needed to understand our decisions and to be assured of the integrity of our operations. Indeed, on matters related to the conduct of monetary policy, the Federal Reserve is already one of the most transparent central banks in the world, providing detailed records and explanations of its decisions. Over the past year, the Federal Reserve also took a number of steps to enhance the transparency of its special credit and liquidity facilities, including the provision of regular extensive reports to the Congress and the public; we have worked closely with the Government Accountability Office (GAO), the Office of the Special Inspector General for the Troubled Asset Relief Program (SIG TARP), the Congress, and private-sector auditors on a range of matters relating to these facilities. While the emergency credit and liquidity facilities were important tools for implementing monetary policy during the crisis, we understand that the unusual nature of those facilities creates a special obligation to assure the Congress and the public of the integrity of their operation. Accordingly, we would welcome a review by the GAO of the Federal Reserve's management of all facilities created under emergency authorities. In particular, we would support legislation authorizing the GAO to audit the operational integrity, collateral policies, use of third-party contractors, accounting, financial reporting, and internal controls of these special credit and liquidity facilities. The Federal Reserve will, of course, cooperate fully and actively in all reviews. We are also prepared to support legislation that would require the release of the identities of the firms that participated in each special facility after an appropriate delay. It is important that the release occur after a lag that is sufficiently long that investors will not view an institution's use of one of the facilities as a possible indication of ongoing financial problems, thereby undermining market confidence in the institution or discourage use of any future facility that might become necessary to protect the U.S. economy. Looking ahead, we will continue to work with the Congress in identifying approaches for enhancing the Federal Reserve's transparency that are consistent with our statutory objectives of fostering maximum employment and price stability. In particular, it is vital that the conduct of monetary policy continue to be insulated from short-term political pressures so that the FOMC can make policy decisions in the longer-term economic interests of the American people. Moreover, the confidentiality of discount window lending to individual depository institutions must be maintained so that the Federal Reserve continues to have effective ways to provide liquidity to depository institutions under circumstances where other sources of funding are not available. The Federal Reserve's ability to inject liquidity into the financial system is critical for preserving financial stability and for supporting depositories' key role in meeting the ongoing credit needs of firms and households. Strengthening our financial regulatory system is essential for the long-term economic stability of the Nation. Among the lessons of the crisis are the crucial importance of macroprudential regulation--that is, regulation and supervision aimed at addressing risks to the financial system as a whole--and the need for effective consolidated supervision of every financial institution that is so large or interconnected that its failure could threaten the functioning of the entire financial system. The Federal Reserve strongly supports the Congress' ongoing efforts to achieve comprehensive financial reform. In the meantime, to strengthen the Federal Reserve's oversight of banking organizations, we have been conducting an intensive self-examination of our regulatory and supervisory responsibilities and have been actively implementing improvements. For example, the Federal Reserve has been playing a key role in international efforts to toughen capital and liquidity requirements for financial institutions, particularly systemically critical firms, and we have been taking the lead in ensuring that compensation structures at banking organizations provide appropriate incentives without encouraging excessive risk-taking. The Federal Reserve is also making fundamental changes in its supervision of large, complex bank holding companies, both to improve the effectiveness of consolidated supervision and to incorporate a macroprudential prospective that goes beyond the traditional focus on safety and soundness of individual institutions. We are overhauling our supervisory framework and procedures to improve coordination within our own supervisory staff and with other supervisory agencies and to facilitate more-integrative assessments of risks within each holding company and across groups of companies. Last spring, the Federal Reserve led the successful Supervisory Capital Assessment Program, popularly known as the ``bank stress test.'' An important lesson of that program was that combining on-site bank examinations with a suite of quantitative and analytical tools can greatly improve comparability of the results and better identify potential risks. In that spirit, the Federal Reserve is also in the process of developing an enhanced quantitative surveillance program for large bank holding companies. Supervisory information will be combined with firm-level, market-based indicators and aggregate economic data to provide a more complete picture of the risks facing these institutions and the broader financial system. Making use of the Federal Reserve's unparalleled breath of expertise, this program will apply a multidisciplinary approach that involves economists, specialists in particular financial markets, payment systems experts, and other professionals, as well as bank supervisors. The recent crisis has also underscored the extent to which direct involvement in the oversight of banks and bank holding companies contributes to the Federal Reserve's effectiveness in carrying out its responsibilities as a central bank, including the making of monetary policy and the management of the discount window. Most important, as the crisis has once again demonstrated, the Federal Reserve's ability to identify and address diverse and hard-to-predict threats to financial stability depends critically on the information, expertise, and powers that it has by virtue of being both a bank supervisor and a central bank. The Federal Reserve continues to demonstrate its commitment to strengthening consumer protections in the financial services arena. Since the time of the previous Monetary Policy Report in July, the Federal Reserve has proposed a comprehensive overhaul of the regulations governing consumer mortgage transactions, and we are collaborating with the Department of Housing and Urban Development to assess how we might further increase transparency in the mortgage process. We have issued rules implementing enhanced consumer protections for credit card accounts and private student loans as well as new rules to ensure that consumers have meaningful opportunities to avoid overdraft fees. In addition, the Federal Reserve has implemented an expanded consumer compliance supervision program for nonbank subsidiaries of bank holding companies and foreign banking organizations. More generally, the Federal Reserve is committed to doing all that can be done to ensure that our economy is never again devastated by a financial collapse. We look forward to working with the Congress to develop effective and comprehensive reform of the financial regulatory framework. Thank you, Mr. Chairman. [The prepared statement of Chairman Bernanke can be found on page 71 of the appendix.] " FOMC20080724confcall--67 65,MS. YELLEN.," Thank you, Mr. Chairman. I support extending the TSLF along with the PDCF, and I am also supportive of the proposal to auction options on TSLF draws. I think we do continue to have money market stress, particularly at quarter-end, and it strikes me as a welltargeted program that might have some success in addressing the strains. On the proposal to extend the term of the TAF loans to 84 days, I do have some qualms, and they have been heightened by our own recent experience with a failing bank and my sense that the most recent bank failure is not going to be our last. I definitely understand the motivation for extending the term of the loans, and I am not saying that I am, on balance, opposed to it. But I do think that the program entails credit risk for Reserve Banks and may actually create complications in facilitating least-cost resolution of troubled banks. My anxiety about this has been heightened by our own recent experience with IndyMac. If you will indulge me for a second, I will tell you the story of what happened there and why I am concerned. IndyMac was closed on July 11. On June 26, just two weeks earlier, the information provided to us by the OTS indicated that IndyMac was a CAMELS 2�rated institution. We monitored Call Report data that showed it to be well capitalized. On the morning of June 26, we approved a loan for $1 billion under primary credit. IndyMac didn't participate in TAF auctions, but it was eligible to do so. If the new 84-day facility had been in operation, it would hypothetically have been eligible to be covered under that. It could have had an 84-day TAF loan. My staff consulted with me on the IndyMac request on that morning of June 26 because it represented a significant escalation in borrowing, and our own monitoring suggested that the institution had been deteriorating. We had informal hints of some concerns at the OTS. It was unknown to us, but in point of fact the OTS had already informed the institution that it had actually been downgraded to a 3. Even so, even if we had known that, it still would have been eligible for primary credit and participation in a TAF auction. Now, the memo we got points out that we can disqualify an institution from participation in a TAF auction on the grounds that we judge it to be in unsound financial condition or that we can on such a judgment move an institution to secondary credit. But we thought that would be a drastic action, and it probably would have been seen as arbitrary. It would have entailed a supervisory judgment that was in conflict with that of the institution's supervisor. We didn't think we had an adequate database to make such a judgment, and we couldn't have done it without making a formal communication to the institution that we had made such a judgment, which we would have been concerned about. Now, with respect to collateral, we thought we were very much overcollateralized. The institution had pledged collateral with us amounting to around $4 billion. We applied standard haircuts and assigned a lendable value of $3.2 billion, so our credit risk appeared to be very well covered by the collateral, and we approved the loan. On that very afternoon of June 26, it became public that Senator Schumer had written a letter to the FDIC and the OTS expressing concern about the institution, and that very evening we learned that the OTS had downgraded the institution to a 5, and that, as of June 30, the OTS expected to declare it to be significantly undercapitalized. We also learned that the FDIC was planning to close the institution within a few weeks. We moved it to secondary credit. We took an additional 10 percent haircut on the collateral. That brought IndyMac's borrowing capacity down to $2.8 billion. But we took the precaution of sending our most senior mortgage specialist from Banking Supervision and Regulation (BS&R) down to the bank to gather information to refine our assessment of the true market value of the collateral, based on that institution's profile and more detail about the collateral than we had had from applying the standard haircuts. He concluded that the haircuts we were taking were drastically too low and advised us to reduce the lendable value of the collateral down to $1.1 billion. We reserved $100 million for non-Fedwire payment system exposure, leaving us with a $1 billion loan and $1 billion of now-assigned, lendable value of the collateral. So, in retrospect, it turns out that we actually did make a $1 billion loan under primary credit to a troubled institution that was undercapitalized under FDICIA guidelines and on the verge of closure. And we did it based on collateral we should have valued at $1.1 billion rather than $3.2 billion. So we did have significant credit exposure, and I think we are lucky we lent only overnight and were paid the next day rather than having an 84-day loan. With the TAF, if we had an 84-day loan outstanding on June 26, we would have had no further capacity to assist in the bank's final days in moving toward what we deemed an FDIC-led least-cost resolution. The bank had lost all access to brokered deposits and also to Federal Home Loan Bank loans after it was downgraded, and our inability to lend any further would almost surely have precipitated a liquidity crisis and a failure well before the FDIC finally closed that institution on July 11. So let me draw a few morals from this shaggy dog tale. First, troubled banks can be downgraded and fail very rapidly. They may be deemed eligible to borrow under primary credit and participate in TAF auctions when in reality they are near failure. Second, it is true we have discretion to judge whether or not to allow an institution to participate in auctions and can exclude an institution that we don't consider in sound financial condition. But, in reality, we deal with hundreds and potentially thousands of banks at the discount window and can't monitor and make independent judgments on the health of all those institutions on an ongoing basis. We do have to rely on primary supervisors for assessments. If we act on our own hunches, we are substituting our judgment for that of primary supervisors. If we decided we wanted to do so, we would be truly taxing the resources of our colleagues in BS&R beyond their capacity to deal with these institutions. Third, we may think that we are overcollateralized, but that judgment can be highly flawed in the case of a troubled institution. Finally, while we may, in principle, demand immediate repayment of any discount window loan, including a TAF term credit, in a failingbank situation such an action can cause the institution's immediate failure, making an orderly least-cost resolution impossible. Now, I know that this applies, we hope, to a handful of institutions and not to most of them; but I don't think that IndyMac is going to be the last failing bank. I do think that this would have worked very badly in that case, and so it does give me qualms about the proposal. " CHRG-111hhrg51591--39 Mr. Hunter," Just a couple of points about what you said, Mr. Chairman. The Federal Government has rather failed in recent years of taking--moving into insurance, and certainly have not made it self-sustaining. The flood program by now, that I ran, should have been self-sustaining. But it isn't, in part because the maps are antiquated, in part because there is still unwise construction that should have been stopped from occurring. That needs to be done, and the mitigation has to work, and the prices have to really meet the risk. And it can, but it has to be enforced. And it isn't. TRIA, for example, is somewhat modeled after the old riot reinsurance program, except the only difference is the riot reinsurance program charged premiums. TRIA doesn't. The Federal Government refused to charge premiums when it took on the risk. Now, that is a decision Congress made, and the Administration. Whether that was right or not, the problem is you can't--a premium of zero is never going to break even. And so that--I wouldn't be so pessimistic. You can fix these things. It takes some will, though, because there is always pressure to go the other direction. And then finally, on too-big-to-fail, it is not just too-big-to-fail. I think those are pretty easy to look at and find. But even within markets, consider title insurance. Two-thirds of the market is in two companies. Are they too-big-to-fail within the title insurance context? That is why I think you have to--the systemic risk regulator has to look at everything. " CHRG-111shrg61651--37 Mr. Zubrow," I do think it is also important to remember that Justice Potter Stewart's remark also went on to say, with respect to pornography, that this is not it. And I think Mr. Volcker is also having the difficulty in saying that it is a very simple definition and it is very easy to see, but he seems to be having difficulty coming up with what that pure definition should be. I think that one of the significant issues that the Committee should is that proprietary trading not only means different things to different people, but in different contexts can mean different things. So, for instance, we obviously, in our regular market-making activities and client-facing activities, often take on positions from clients. We then need to hedge those risks. Now is that proprietary trading? Those risks have been given to us. They came out of client market-making activities, but now they are the bank's risks. So, if we want to go out and hedge those risks prior to being able to flatten those positions, that obviously could be interpreted by some as a form of proprietary trading. I would agree with Gerry's comment--if you take the extremely narrow definition and say that you put a group of traders in walled-off area, give them an amount of capital. That is not a business that we are in. That is not something that we find strategically attractive. Obviously, if we were to eliminate that type of activity, that would not have a particular impact on the firm. " CHRG-110hhrg46595--104 Mr. Hodes," Thank you, Mr. Chairman. I want to thank the witnesses for appearing today, and thank you for the work you did in putting together your business plans. I think they have gone some way to showing that you are connecting the dots because a couple of weeks ago, at least what I heard from my constituents, was that you folks simply were in another universe and you weren't connecting the dots and that you didn't have the answers that people expected before exposing taxpayer money, again, given what we have just done with the financial system bailout, to loss of taxpayer money. I am not opposed to helping your industries. I think that they are crucial to our economy, the jobs that are connected are upper most in my mind. I have met with representatives of the UAW in New Hampshire, I have met with the auto dealers who, despite the fact that a third of them are going to disappear under the best of circumstances, are supporting helping the auto industries. But I think that, even assuming your business plans worked and we spent $34 billion, what I am hearing here today from my colleagues, and what I have heard from others, including the auto dealers, is that is only one-third of the problem. You can hold yourselves open for business with the money we give you, the $34 billion, and I think that is a short-term fix, it will get you on the road, but not get you down all the way to a long-term transformation. But the issue with the credit availability is a serious, serious issue. That is the second component to the true cost to the taxpayers. And so you have heard from the ranking member and the chairman that there is support for the idea, perhaps, of the transformation of bank holding companies and ILC, and also from other members about accessing the TARP funds. What amount of money do you put on the need of the credit companies, whether it is spent in an asset purchase program or direct injection, or whatever Secretary Paulson comes up with as plan A, B, C or D, what amount of money for the credit companies do you see as necessary? And would they accept conditions that say the money they get has to go for auto loans as opposed to what we did with the bailouts where the banks are sitting on the money? That is question number one. And number two, don't you think we also are going to realistically need incentives for consumers who are worried about losing their jobs, losing their houses, and are frankly concerned about spending $30,000 or $40,000 on a car purchase? And if that is going to be required, what is the dollar amount, what is the plan for that, how do you think it ought to happen, and aren't we really talking about a really much bigger number than $34 billion when those are factored in? " FOMC20080318meeting--168 166,VICE CHAIRMAN GEITHNER.," This is the Bluebook equilibrium real funds rate chart. But any way you look at it, the real fed funds rate is closer to best estimates of equilibrium than during any downturn of the past two decades or similar periods of time. There is no gap between the estimated real rate today and the center of the estimate of where equilibrium is. If you look back to what that gap was in 1992, in 2001-02, or in 2003, there was a substantial gap, as most judgments about policy would suggest was necessary. I understand that there is a huge amount of uncertainty about estimates of equilibrium, but we can't be facing both the most serious risk of a financial crisis and of a deep, prolonged recession in 50, 30, or 20 years and at the same time the risk of having a very substantial rise in underlying inflation over the medium term. It seems to me that we are going to have one or the other. The choice we face, of course, is which risk we are prepared to take. Which mistake is the easier to correct for? It is a very hard judgment to make. But I think we have to be confident that, if we end up being successful in averting the risk of a very, very dangerous, damaging spiral in the financial markets with the consequences of a very deep recession or a deeper recession than in the early 1990s, then we will be able to deal with the likely consequences that we will have more inflation and less moderation than we now anticipate. I guess I don't understand why we would not be confident in that. So let me just say that I don't think this is easy. Like many of you, I think that it would be great if we got away with 50, but I think that is not tenable--not even close in this context. Even though it would be nice if we had a consensus in the United States about a set of fiscal measures that we think would be good on the merits, we can't make monetary policy in a framework where we condition our actions on actions by the Congress. In an environment like this, it is not possible. If we do the right thing, does that mean it takes the pressure off them? Maybe, but probably not so much. But it can't constrain us from doing what is appropriate now. Just one final thing: People who know this stuff quite well, who are reasonably calm people, say, ""This is possibly the worst financial crisis in 50 years, and the most challenging set of pressures facing the central bank in 20 or 30 years."" Think about that in this context. Okay? It is no surprise that we disagree; it is no surprise that the range of agreement about what we see and what we should do is going to be wide in that context. But just think very carefully about the signal it sends to the world at this moment to be explicit in public about the degree of dispersion about our views. Just think carefully about it because this is a special moment. I fully support the language and the action in alternative A. President Fisher, I would not amend the last sentence to say ""without sacrificing"" partly because I think we need to project confidence in our capacity to manage long-term inflation outcomes. I am ambivalent, as you know, Mr. Chairman, about that clause that President Fisher suggested we delete about reflecting a projected leveling out. The virtue is that it explains and underpins, therefore, the basis for a medium-term forecast. The vice in it is that, as the Chairman himself said, the first part may seem like a thin reed on which to base our forecast, given what has been happening. I actually think, Governor Mishkin, that acknowledging some indicators of inflation expectations--it is really about uncertainty having increased--is helpful to our credibility. At the margin, it helps, even though, sure, you can say that we really can't know what they are telling us about the market. " fcic_final_report_full--261 Committee members discussed the “considerable financial turbulence” in the sub- prime mortgage market and that some firms, including Countrywide, were showing some strain. They noted that the data did not indicate a collapse of the housing mar- ket was imminent and that, if the more optimistic scenarios proved to be accurate, they might look back and be surprised that the financial events did not have a stronger impact on the real economy. But the FOMC members also expressed con- cern that the effects of subprime developments could spread to other sectors and noted that they had been repeatedly surprised by the depth and duration of the dete- rioration of these markets. One participant, in a paraphrase of a quote he attributed to Winston Churchill, said that no amount of rewriting of history would exonerate those present if they did not prepare for the more dire scenarios discussed in the staff presentations.  Several days later, on August , Countrywide released its July  operational results, reporting that foreclosures and delinquencies were up and that loan produc- tion had fallen by  during the preceding month. A company spokesman said lay- offs would be considered. On the same day, Fed staff, who had supervised Countrywide’s holding company until the bank switched to a thrift charter in March , sent a confidential memo to the Fed’s Board of Governors warning about the company’s condition: The company is heavily reliant on an originate-to-distribute model, and, given current market conditions, the firm is unable to securitize or sell any of its non-conforming mortgages. . . . Countrywide’s short-term funding strategy relied heavily on commercial paper (CP) and, espe- cially, on ABCP. In current market conditions, the viability of that strat- egy is questionable. . . . The ability of the company to use [mortgage] securities as collateral in [repo transactions] is consequently uncertain in the current market environment. . . . As a result, it could face severe liquidity pressures. Those liquidity pressures conceivably could lead eventually to possible insolvency.  Countrywide asked its regulator, the Office of Thrift Supervision, if the Fed could provide assistance, perhaps by waiving a Fed rule and allowing Countrywide’s thrift subsidiary to support its holding company by raising money from insured deposi- tors, or perhaps through discount-window lending, which would require the Fed to accept risky mortgage-backed securities as collateral, something it never had done and would not do—until the following spring. The Fed did not intervene: “Substan- tial statutory requirements would have to be met before the Board could authorize lending to the holding company or mortgage subsidiary,” staff wrote. “The Federal Reserve had not lent to a nonbank in many decades; and . . . such lending in the cur- rent circumstances seemed highly improbable.”  The following day, lacking any other funding, Mozilo recommended to his board that the company notify lenders of its intention to draw down . billion on backup lines of credit.  Mozilo and his team knew that the decision could lead to ratings downgrades. “The only option we had was to pull down those lines,” he told the FCIC. “We had a pipeline of loans and we either had to say to the borrowers, the cus- tomers, ‘we’re out of business, we’re not going to fund’—and there’s great risk to that, litigation risk, we had committed to fund. . . . When it’s between your ass and your image, you hold on to your ass.”  FOMC20080805meeting--187 185,MS. DANKER.," Yes. This vote includes the alternative B language from the table distributed this morning and the directive from the Bluebook. ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 2 percent."" Chairman Bernanke Vice Chairman Geithner Governor Duke President Fisher Governor Kohn Governor Kroszner Governor Mishkin President Pianalto President Plosser President Stern Governor Warsh Yes Yes Yes No Yes Yes Yes Yes Yes Yes Yes " CHRG-111hhrg52406--28 HARVARD UNIVERSITY Ms. Warren. Thank you, Chairman Frank, for inviting me here. Thank you, Ranking Member Bachus. I also want to thank Congressman Delahunt and Congressman Miller who were able to put together the first version of this and introduce it in this House. I appreciate the invitation to appear. I should note, I speak only for myself, not on behalf of any other group or as a lobbyist for anyone. I am here to deal with a problem that can be explained in blunt words: the consumer credit market is broken. This is not about people who went to the mall and charged up what they couldn't afford to pay, and this is not about people who bought five bedroom houses that they can't make the payments on. Those people should deal with the consequences. This is about people who get trapped by credit agreements themselves. Everyone in this room recognizes the problem. Consumers cannot compare financial products because the products have become too complicated. Make a comparison between four credit cards, put the papers on the table, and you would have more than 100 pages of dense, fine-print text to work through. And, quite frankly, even if you invested the hours to do it, I don't know if you would be able to understand it. I say that only because I teach contract law at Harvard Law School, and I can't understand many of the terms. You can't tell which card is cheaper, which card is safer. That is not choice. Companies compete today by offering nominal interest rates and free gifts and then loading tricks and traps in the fine print where nobody else can see them. The result is that bad cards produce more profits than good cards and the market can't drive consumers toward cheaper, lower-risk products. Healthy markets thrive with information and level playing fields, not with tricks and traps. Broken credit markets also tilt the playing fields between big and small lenders. Local banks and credit unions may offer better products, but when the customers can't make easy comparisons the smaller banks, the ones with the smaller advertising budgets lose out. Broken credit markets also feed excessive risk into the system. Bad products carry very high default rates. And this is true across-the-board. Aggregated together, this can bring down families, bring down banks, bring down retirement funds, and ultimately bring down our whole economy. Systemic risk regulation starts by not feeding high risk products into the system. A Consumer Financial Protection Agency can fix a broken market. An agency that focuses on transparency can promote, for example, a plain vanilla product. Consider if we had a Consumer Financial Protection Agency, 2-page plain vanilla, credit card agreement. You could put four of them on the table, the differences between them, the interest rates, the penalties, what causes the penalties, even the free gifts can be put out there in bold. That means that in less than a minute, you can tell which one is cheaper, which one is riskier and how much those free gifts actually cost you. That is choice, that is a meaningful choice made possible by regulation that repairs a broken market. Agencies can also reduce overall regulatory burdens for lenders. I think everyone in here agrees we should remove the layers of contradictory and inefficient regulation. By putting things in a single place and by promoting plain vanilla safe harbor mortgages, credit cards and other products that automatically pass regulatory muster, we make it very cheap for issuers to issue these products. They are already through the regulatory process. Banks can offer something else, but they have to show that what they offer meets basic safety standards, which in this case means a customer can read it and understand it in 5 minutes or less. Regulatory agencies are not perfect, but they can do a lot of good. In the 1920's, anyone with a bathtub and some bottles of chemicals could sell drugs in America. The FDA put a stop to that. Dirty meat could be sold to families. The Department of Agriculture put a stop to that. In the 1960's, babies' car seats collapsed on impact, 8-year old boys shot out their cousins' eyes with BB guns, and infants chewed on toys covered in lead paint. The Consumer Protection Safety Commission put a stop to that. We have tried for 70 years to combine consumer protection with other financial service regulatory functions. This structure has not worked. To talk about keeping these two together is to say we are satisfied with the system and want it to go on as it has before. I think it is time for change. We need someone in Washington who cares primarily about families, who cares about consumers, who looks at the products not from the point of view exclusively of bank profitability but who looks at these products in a much larger sense about what they mean to the family, what they mean to communities, what they mean to the economy as a whole. This is an historic moment. You can repair a broken market, you can take the first steps in preventing the next financial crisis, and most of all, you can put a Consumer Financial Protection Agency in place to stop the tricks and traps that are robbing American families every day. Thank you, Chairman Frank. [The prepared statement of Professor Warren can be found on page 199 of the appendix. ] " FOMC20070918meeting--167 165,MS. DANKER.," I’ll be reading the directive from page 35 of the Bluebook, and the assessment of risks from the table distributed today. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 4¾ percent.” Then: “Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.”" FOMC20080130meeting--114 112,MS. LIANG.," We have revised this forecast up quite a bit since the first time we looked at this maybe in June or August, in part because of lower house prices and tighter credit conditions. The model requires as inputs defaults and prepayments, and the prepayment rates have been fairly slow but not zero. The 2006 vintage, as it approaches its first reset, has been that 20 to 25 percent are able to prepay. They are able to find something. So we don't want to assume that none of them will be able to. The model would approach both of those, so that is the positive side. The downside is that our forecast, with the national house-price assumption of roughly minus 7 over the forecast period, does imply house-price declines on the order of minus 20 percent a year or more in California, Florida, and some other places. That does leave the loan-to-value ratio, as I mentioned, pretty high for many borrowers. We have never had this kind of episode, so we have to make a judgment about the point at which subprime borrowers walk away from their houses. The current assumption is that at about 140 percent we just say you are out; but it has to be almost an assumption that, if by then you hadn't defaulted, we would push you out. So there is an upside. On the other hand, saying 40 percent of the outstanding stock will default over two years sounds like a big projection as well. So we tried to balance. There are risks on both sides, for sure. " FOMC20070321meeting--226 224,MR. REINHART.," First, I’d like to thank everyone for validating my own career decision. [Laughter] Second, in your description you use the word “fundamentals,” which might be a substitute for “financial conditions.” You could say “supported by still-favorable fundamentals, including gains in income and the waning of the correction in the housing market.”" FinancialCrisisReport--247 B. Background (1) Credit Ratings Generally Credit ratings, which first gained prominence in the late 1800s, are supposed to provide independent assessments of the creditworthiness of particular financial instruments, such as a corporate bond, mortgage backed security, or CDO. Essentially, credit ratings predict the likelihood that a debt will be repaid. 957 The United States has three major credit rating agencies: Moody’s, S&P, and Fitch Rating Ltd., each of which is a NRSRO. By some accounts, these three firms issue about 98% of total credit ratings and collect 90% of total credit rating revenue. 958 Paying for Ratings. Prior to the 1929 crash, credit rating agencies made money by charging subscription fees to investors who were considering investing in the financial instruments being rated. This method of payment was known as the “subscriber-pays” model. Following the 1929 crash, the credit rating agencies fell out of favor. As one academic expert has explained: “Investors were no longer very interested in purchasing ratings, particularly given the agencies’ poor track record in anticipating the sharp drop in bond values beginning in late 1929. … The rating business remained stagnant for decades.” 959 In 1970, the credit rating agencies changed to an “issuer-pays” model and have used it since. 960 In this model, the party seeking to issue a financial instrument, such as a bond or security, pays the credit rating agency to analyze the credit risk and assign a credit rating to the financial instrument. Credit Ratings. Credit ratings use a scale of letter grades, from AAA to C, with AAA ratings designating the safest investments and the other grades designating investments at greater risk of default. 961 Investments with AAA ratings have historically had low default rates. For example, S&P reported that its cumulative RMBS default rate by original rating class (through September 15, 2007) was 0.04% for AAA initial ratings and 1.09% for BBB. 962 Financial 957 9/3/2009 “Credit Rating Agencies and Their Regulation,” report prepared by the Congressional Research Service, Report No. R40613 (revised report issued 4/9/2010). 958 Id. 959 “How and Why Credit Rating Agencies Are Not Like Other Gatekeepers,” Frank Partnoy, University of San Diego Law School Legal Studies Research Paper Series (5/2006), at 63. 960 9/3/2009 “Credit Rating Agencies and Their Regulation,” report prepared by the Congressional Research Service, Report No. R40613 (revised report issued 4/9/2010) . A few small credit rating agencies use the “subscriber-pays” model. However, 99% of outstanding credit ratings are issued by agencies using the “issuer-pays” model. 1/2011 “Annual Report on Nationally Recognized Statistical Rating Organizations,” report prepared by the SEC, at 6. 961 The Moody’s rating system is similar in concept but with a slightly different naming convention. For example its top rating scale is Aaa, Aa1, Aa2, Aa3, A1, A2, A3. 962 Prepared statement of Vickie A. Tillman, Executive Vice President, Standard & Poor’s Credit Market Services, “The Role of Credit Rating Agencies in the Structured Finance Market,” before U.S. House of Representatives Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, Cong.Hrg. 110-62 instruments bearing AAA through BBB- ratings are generally called “investment grade,” while those with ratings below BBB- (or Baa3) are referred to as “below investment grade” or sometimes as “junk” investments. Financial instruments that default receive a D rating from S&P, but no rating at all by Moody’s. CHRG-111shrg55117--133 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CORKER FROM BEN S. BERNANKEQ.1. 13(3) Authority--By what key criteria will the Board of Governors determine when the unusual and exigent circumstances that permitted the use of the Board's extraordinary powers under section 13(3) of the Federal Reserve Act are no longer present? (Not lots of criteria, but the top three. Follow-up: Did the Board's General Counsel write a memo spelling out these powers? Would you share that analysis with the Committee? Are there any constraints on the Board's discretion here? If so, what are they?)A.1. To authorize credit extensions to individuals, partnerships, or corporations under section 13(3) of the Federal Reserve Act, the Board must find that, among other things, ``unusual and exigent circumstances'' exist. These terms are not defined in the Act and are committed to the Board's discretion. In exercising this discretion, the Board must act reasonably. When it approved the establishment and extension of the various lending facilities under section 13(3) authority, the Board made determinations that unusual and exigent circumstances existed based on its assessment that the condition of the financial markets presented severe risks to the integrity of the financial system and to prospects for economic growth. The approvals of lending programs for individual financial institutions were based on an assessment of the potential disruption associated with the disorderly collapse of the particular firm. The Board reached these conclusions after careful evaluation of all available economic and market data and advice of the Board's General Counsel. The determinations are consistent with the manner in which Congress intended the 13(3) authority to be used. As noted in the Senate report on the 1991 amendments to section 13(3), ``with the increasing interdependence of our financial markets, it is essential that the Federal Reserve System have the authority and flexibility to respond promptly and effectively in unusual and exigent circumstances that might disrupt the financial system and markets.'' \1\--------------------------------------------------------------------------- \1\ S. Rep. No. 102-167, at 203 (Sept. 19, 1991). The Board has already taken steps to terminate or scale back some of the extraordinary liquidity facilities that it has established, including section 13(3) facilities. For example, the Board has decided not to extend the Money Market Investor Funding Facility when it expires in October 2009, and the Federal Reserve has reduced amounts offered under some of its liquidity facilities, such as the Term Securities Lending Facility. In making such determinations to date, and in making similar determinations in the future, the Board has and will likely continue to review a broad range of indicators of financial market conditions. These indicators include credit and liquidity spreads in financial markets, information on trading and issuance volumes, measures of market volatility, assessments of the strength of individual financial institutions, and other measures. The Board's focus will be on the capability of financial markets and institutions to support a sustained recovery in economic activity.Q.2. What are the key objectives of the Board's various special facilities: How will we know if they have been successful? How ---------------------------------------------------------------------------will we know if they have failed?A.2. In general, the Federal Reserve has established special facilities over the crisis for two purposes. The facilities that have been made available for multiple institutions (for example, the Term Auction Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility) are intended to support the extension of credit to households and firms and thus contribute to a reduction in financial strains and to foster a resumption of economic growth. These programs seem to have been helpful in addressing strains in financial markets. Financial data including various risk spreads and indicators of market functioning as well as anecdotal reports from market participants have indicated that strains in financial markets have eased substantially in recent months, and particularly so in those markets in which the Federal Reserve has provided liquidity support. Although it is too early to say whether the improvement in financial conditions will be sufficient to support a sustained pickup in economic growth, economic activity appears to be leveling out, and the prospects for a resumption of economic growth over coming quarters have improved. Other facilities--for example, those related to the difficulties of Bear Stearns and AIG--were established to prevent the disorderly failure of large, systemically important nonbank financial institutions and thus avoid an exacerbation of financial strains during a period when financial stress was already intense. By successfully achieving this objective, these actions helped prevent further harm to the U.S. economy.Q.3.a. On commercial real estate--What are the expectations/benchmarks with the TALF facility? Will it be sufficient and timely enough in facilitating private lending/investing, or are you considering other programs?A.3.a. The TALF program has allocated $100 billion to fund loans with up to 5 years maturity, including loans backed by newly issued commercial mortgage-backed securities (CMBS). We believe that this amount, especially if coupled with a modest revival of the new-issue CMBS market later next year, should be sufficient to allow creditworthy borrowers with maturing loans currently in CMBS pools to refinance. The Federal Reserve and the Treasury have recently indicated that at this time they do not anticipate adding additional collateral types to the TALF facility.Q.3.b. Given the lag time needed to get securitized lending going (4 months), how do you handle the reality (as expressed by market experts and participants) that the markets need to know NOW (not ``year-end'') whether the program will be extended in order to see any usefulness in the next several months?A.3.b. Because of the long lead time required to assemble CMBS, and because the market for newly issued CMBS appears likely to remain impaired for some time, the Federal Reserve and the Treasury announced on August 17, 2009, that TALF loans against newly issued CMBS will be available through June 30, 2010. ------ CHRG-111hhrg48674--106 Mr. Bernanke," Yes, sir. The law requires that we find that conditions be unusual and exigent. So when financial markets begin to look more normal, we would no longer have the authority. " FOMC20070131meeting--322 320,MR. REIFSCHNEIDER.,"4 Thank you, Governor Kohn. Brian Doyle, Vincent Reinhart, and I will be speaking this morning on the material labeled “Staff Presentation on Producing and Publishing Economic Forecasts.” As the top panel of your first exhibit notes, the Federal Reserve regularly provides the public with information on the outlook in the Monetary Policy Report, congressional testimony, the FOMC minutes, and the statement. You presumably undertake this effort with an eye toward advancing the goals of economic performance, public discourse, your own internal discourse, and efficient operations. A key issue in your deliberations today is whether changing your practices in this area would advance these goals further or achieve a better tradeoff. As shown in the bottom panel, this morning Brian, Vincent, and I will address three questions related to this issue. I will start with the production and publication options that are open to the Committee. Brian will then discuss what we can learn from the international experience. Finally, Vincent will consider the governance issues that would arise under alternative arrangements. Many ways of changing your current practices are possible. Exhibit 2 focuses on one fundamental choice that you confront in this regard—namely, how to produce the forecast. As noted in the top panel, you have three main options. First, you could continue to produce independent forecasts, with each of you solely responsible for your own forecast. Second, you could choose to produce a single centralized forecast, working together as the whole Committee or delegating responsibility to a subcommittee. Finally, you could adopt an intermediate position and produce 4 Material used by Mr. Reifschneider, Mr. Doyle, and Mr. Reinhart is appended to this transcript (appendix 4). coordinated forecasts, with your individual projections conditioned on common assumptions for factors such as oil prices and fiscal policy. As highlighted in the bottom panel, your choice among these three options has important implications for, among other things, your communications with the public and the operational cost of forecast-related activities. To see this, consider one important communication task, the telling of the central story of the outlook. As noted in the first row under the independent option, distilling an informative message from multiple forecasts is difficult, even if those forecasts provide a considerable amount of detail about the outlook. In fact, it is an open question as to whether it would always be possible to craft a central narrative that would command the consent of a majority of the Committee, given the diversity of your views. Moving to the right, the distillation task under the coordinated approach might be simplified a bit because your individual forecasts would share some common elements. Nevertheless, telling the central story would remain difficult if, after settling on, say, a common path for oil prices, you still disagreed markedly about its economic implications. In contrast, as the rightmost entry notes, the telling of the central story would be relatively easy under the centralized option because—abstracting from the difficulties of producing such a forecast—the single projection would provide a clear and coherent message. Your production choice has important implications for another communication task—conveying the diversity of views on the Committee about the outlook. As noted in the second row of the table, the independent option naturally reveals this diversity through your individual forecasts. To a large degree, the same is true under the coordinated option, although conditioning on common assumptions would obscure some of the possible sources of diversity. Finally, the centralized option would not reveal the diversity of your thinking unless the published outlook summary included additional comments about alternative views. Your production choice also has important implications for the operational costs of both producing and publishing the forecast. Forecast production is a relatively low-cost task under the independent option because you incur no expense in coordinating your forecasting efforts. Still, you could find yourselves devoting more resources to forecasting if you chose to publish your individual projections. Moving to the coordinated option, here preparing the forecast would be more costly because you would need to spend time choosing a common set of assumptions, but you could limit these costs if you settled on a standard process for this task. Finally, producing a centralized forecast would be very costly, especially at first, because of the wide range of economic issues on which you would need to reach consensus. Given the practical difficulties of achieving such agreement with a group as large as the FOMC, making this option feasible might require delegating the preparation of the unified projection to a subcommittee. Finally, there are the operational costs of forecast publication. This task may be burdensome under the independent option, especially if all of you wish to participate actively in the preparation of the text as you now do with the minutes. In fact, given the inherent difficulty of crafting an accurate and informative central message from multiple forecasts, negotiating the language of an outlook summary as a group would likely be even more time-consuming than preparing the minutes if the summary is to be anything more than a bare-bones listing of numbers. Publishing the forecast under the coordinated option also may be burdensome, for the same reasons. However, choosing the centralized option could make forecast publication less costly, partly because you would already have reached agreement on the economic factors influencing the outlook. You could reduce costs further if you delegated responsibility for both producing and summarizing the forecast to a subcommittee. The top panel of your next exhibit considers some of your many publication choices. If you choose to continue producing individual forecasts, you could release more information about those projections—for example, by publishing the forecasts themselves. Such a step would reveal more about the diversity of your thinking, although it might risk diverting attention from any consensus about the outlook. Another option available under all three production choices would be to provide more forecast details, either numerically or in qualitative form. Such a step would facilitate telling a more informative story about the outlook, although it would also create additional dimensions for disagreement. A third possibility would be to lengthen the forecast period. This step could reveal more fully how you expect any economic shocks and imbalances to play out and thus might enhance public understanding of the basis for your policy actions; it could also provide more information about your policy objectives and expectations for the long run. A fourth possibility would be to publish information about the outlook more frequently than you now do. Such a change might help to clarify how you see the forecast and monetary policy responding to incoming data, but it would also increase operational costs proportionately. Finally, you have the option of publishing fan charts and confidence intervals for your projections. This information could help to emphasize the inherent uncertainty of the outlook and the conditionality of monetary policy. Before you could take this step, however, you would have to settle some issues involving the empirical basis of this material. The bottom panel of the exhibit addresses two options that you have for setting the projected federal funds rate. The first option is to condition the outlook on what you see as “appropriate” monetary policy. If you produce independent forecasts, each of you would continue to make this determination on your own, but under the centralized approach and perhaps the coordinated one, you would need to do this as a group. As noted in the first bullet point, publishing details on what you see as the appropriate path of the fed funds rate could facilitate telling a more informative story about the role played by monetary policy in the outlook. Describing your policy assumptions qualitatively might achieve this objective; alternatively, you could release, say, the central tendency of your specific fed funds rate projections. One possible drawback to publishing an “appropriate” policy path is that the public might misinterpret it as a promise, especially at first; for this reason, you might wish to pair any published fed funds rate path with information on forecast uncertainty. Releasing information on the fed funds rate might also generate public criticism and political pressures. A second option for setting monetary policy is to condition the outlook on a flat fed funds rate or on the path consistent with market expectations. This approach might mitigate some of the misinterpretation and political problems associated with the release of an appropriate policy path. However, conditioning the outlook on such a path would alter the nature of the forecast and so create communication challenges. In particular, your forecasts would no longer represent your best guess for the likely evolution of the economy, to the extent that a flat fed funds rate or a market-based path differs from what you, individually or as a group, think will be necessary. For this reason, the forecast summary would require some statement about the desirability of the projected outcome to avoid misunderstanding. You might even find it necessary to provide guidance about how the policy path would have to change to bring about a more “appropriate” outcome—a step that would likely generate its own controversies. I will now turn the floor over to Brian." FinancialCrisisReport--31 Synthetic CDOs. Some investment banks also created “synthetic CDOs” which mimicked cash CDOs, but did not contain actual mortgages or other assets that produced income. Instead, they simply “referenced” existing assets and then allowed investors to use credit default swaps to place bets on the performance of those referenced assets. Investors who bet that the referenced assets would maintain or increase in value bought the CDO’s securities and, in exchange, received periodic coupon payments to recoup their principal investment plus interest. Investors who bet that the referenced assets would lose value or incur a specified negative credit event purchased one or more credit default swap contracts referencing the CDO’s assets, and paid monthly premiums to the CDO in exchange for obtaining a large lump sum payment if the loss or other negative credit event actually occurred. Investors in synthetic CDOs who bet the referenced assets would maintain or increase in value were said to be on the “long” side, while investors who bet the assets would lose value or fail were said to be on the “short” side. Some investment banks also created “hybrid CDOs” which contained some cash assets as well as credit default swaps referencing other assets. Others created financial instruments called CDO squared or cubed, which contained or referenced tranches from other CDOs. Like RMBS mortgage pools and cash CDOs, synthetic and hybrid CDOs pooled the payments they received, designed a waterfall assigning portions of the revenues to tranches set up in a certain order, created securities linked to the various tranches, and then sold the CDO securities to investors. Some CDOs employed a “portfolio selection agent” to select the initial assets for the CDO. In addition, some CDOs employed a “collateral manager” to select both the initial and subsequent assets that went into the CDO. Ratings Used to Market RMBS and CDOs. Wall Street firms helped design RMBS and CDO securities, worked with the credit rating agencies to obtain ratings for the securities, and sold the securities to investors like pension funds, insurance companies, university endowments, municipalities, and hedge funds. Without investment grade ratings, Wall Street firms would have had a more difficult time selling structured finance products to investors, because each investor would have had to perform its own due diligence review of the product. In addition, their sales would have been restricted by federal and state regulations limiting certain institutional investors to the purchase of instruments carrying investment grade credit ratings. Still other regulations conditioned capital reserve requirements on the credit ratings assigned to a bank’s investments. Investment grade credit ratings, thus, purported to simplify the investors’ due diligence review, ensured some investors could make a purchase, reduced banks’ capital calls, and otherwise enhanced the sales of the structured finance products. Here’s how one federal bank regulator’s handbook put it: “The rating agencies perform a critical role in structured finance – evaluating the credit quality of the transactions. Such agencies are considered credible because they possess the expertise to evaluate various underlying asset types, and because they do not have a financial interest in a security’s cost or yield. Ratings are important because investors generally accept ratings by the major public rating agencies in lieu of conducting a due diligence investigation of the underlying assets and the servicer.” 42 FOMC20080625meeting--189 187,MR. ALVAREZ.," Well, as you can tell from Art's presentation, there's been a significant amount of information-sharing and collaboration already between the Federal Reserve and the SEC. So we've taken this opportunity simultaneously with what's going on with the primary dealers to fashion a document that will lay out a framework for how this information-sharing and collaboration will go forward. We've made some pretty good progress on a document, but we're still negotiating. In fact, the Chairman is negotiating this afternoon with Chairman Cox. This is one in which the principals have been intimately involved. The agreement as it is currently structured really has two parts. The first part outlines plans for sharing information between the two agencies. Here I would divide the world into two pieces. There are the consolidated supervised entities (CSEs), which are the four large investment banks--Goldman Sachs, Morgan Stanley, Lehman Brothers, and Merrill Lynch. We have agreed to share information and analysis of the financial condition, risk management, internal controls, capital, liquidity, and funding resources of those firms. The agreement is focused primarily on those areas--so the financial condition, liquidity, and risk management of the firms. As you know, we have accessed information from these companies in connection with our providing liquidity through the PDCF and the TSLF, so we'll share that with the SEC. Similarly, the SEC, which is the primary regulator for those and has access to much more information, will share their information with us. We've also agreed to share information and analysis on various financial markets that these companies are intimately involved in--in particular, the tri-party repo market and the interbank lending market. Now, two bank holding companies participate in the SEC's CSE program-- Citigroup and JPMorgan Chase. We have agreed to share with the SEC the same type of financial and risk-management information regarding those two firms but only to the extent that that information affects the broker-dealers that are controlled by those two firms. So we are not expecting, nor is the SEC expecting us, to share information that relates to the condition of the bank or the condition of the other nonbank portions of either of those two firms--just the part related to their broker-dealer. We have an interest here in the Federal Reserve in the financial condition of broker-dealers that are not in the CSE program. That would be any broker-dealer that's in a bank holding company regulated by the Federal Reserve. Our plan is to include an information-sharing arrangement regarding those institutions as well. More broadly, the SEC would provide us with information on an ongoing basis about the financial condition and risk management, internal controls, capital, liquidity, and funding resources of all broker-dealers that are controlled by a bank holding company. This would allow us access beyond what we're currently getting. Right now we're getting primarily FOCUS reports on the broker-dealers, which are not always the most informative documents. So we'll get more access. We also are expecting to agree to provide similar kinds of financial and risk-management information to the SEC, again to the extent that the information affects the brokerdealer. So we would not be routinely providing information about bank holding companies related to the bank or related to the nonbanking operations that are not broker-dealers. We also are expecting to include a provision that outlines several existing agreements that we have for sharing information regarding some of the clearing companies--DTC in particular--transfer agents, municipal securities dealers, and investment advisers. This would simply incorporate, without changing, the arrangements we already have. An essential part of all this sharing of information is that both agencies would agree to keep the information confidential. In addition, the SEC is agreeing not to use our exam or supervisory information, in particular any opinions that we might have, in their enforcement actions or investigations without the permission of the Federal Reserve. The second part of the agreement, as we're working through it, relates to supervisory expectations for the four large investment banks and for the primary dealers that have access to the PDCF and the TSLF. There the current proposal is that the two agencies would agree to collaborate and coordinate with each other in obtaining access to the information on the financial condition of these organizations and in setting supervisory expectations concerning the capital, liquidity, risk management, and funding for the CSEs and the primary dealers. We'd also collaborate and coordinate our communications to those entities about supervisory expectations, something that's already begun with Art and his group. The memorandum of understanding (MOU) is intended to serve as a bridge from the existing world to whatever brave new world the Congress may put together. But it is not tied specifically to the PDCF or the TSLF and is intended to last beyond access to those facilities. It also does not change the legal authority that either of the two agencies has. We continue to have full, unfettered legal authority over bank holding companies. They continue to have full, unfettered authority over the brokerdealers. But we do agree to talk more, collaborate more, and coordinate more. As I mentioned, the MOU is substantially worked out. We are still, though, in negotiation over a couple of key points. Our goal is to have it done this week, we hope with an announcement at the end of the week or sometime next week. We expect that the terms of the MOU will be made public. As soon as we have something that's concrete enough, we'll also send that around to you. " CHRG-111hhrg58044--401 Mr. Cohen," Obviously, you do not know. I will tell you it is a fact. Anybody would know it is a fact. We had 400 years of slavery and 100 years of Jim Crow as distinguished from another group who had property, who owned slaves, who sold slaves, who had discriminatory practices where they could have advantages and they could get credit and they could get loans. They owned the insurance companies and the banks and the credit bureaus, so they had the wealth. When they lose their job or they have a difficult financial time, they have mama or daddy or grand-daddy's money to fall back on. Their credit scores are good. Yet when you look at the credit scores, you say that credit score indicates whether they do good work and have hard values. I submit to you good work and hard values is not a constant. If you have money to fall back on, resources, because of family wealth, you submit that shows because your credit report is good that you have good work habits and hard values, that credit history equals hard work. That is not necessarily true. Credit history shows you have family sometimes and you have support from years and years of opportunity that was denied others, and the fact is the Equal Employment Opportunity Commission has sued certain people over the practice of using credit reports because they believe it has an effect, it is a racial barrier, and there are racial disparities, and it should be pursued. I think it should be, too. I think what you are talking about is a world where all is equal. If you do statistics, Ms. Fortney, you are great on statistics, I think you were thinking about fraud and not accidents. Mr. Green was talking about accidents. There is no way to predict accidents. Maybe a few people might not file claims because they can afford it. You are submitting people who have bad histories might commit fraud, have an accident, which really is not an accident, so they can make a report and get some money. I think that is what you are alluding to. Mr. Hensarling talking about discriminating against the person who does not have a good credit rating, you do not discriminate against him, you let that person, he or she operate against the other person on an equal basis, and the employer can choose them on who can do the best job. Mr. Pratt, you said a lot of jobs do not use credit reports. If that is the case, would you agree that maybe we should pass a bill to make sure that those jobs that you concur where they do not use credit reports now, like skills, etc., that there should not be the permission to use credit reports? Could you sit down with us and come up with those particular industries? " FOMC20081029meeting--315 313,MS. DANKER.," Yes. This vote encompasses the language of alternative A that was in the package passed out earlier today as well as the directive from the Bluebook, which states the following: ""The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 1 percent."" Chairman Bernanke Vice Chairman Geithner Governor Duke President Fisher Governor Kohn Governor Kroszner President Pianalto President Plosser President Stern Governor Warsh Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes " FOMC20050322meeting--137 135,MR. REINHART.," You can’t use it to signal the direction of rates. So if it stands in isolation—that is, if there are no other statements providing guidance in that portion of the announcement—you won’t be telling market participants anything particularly useful. A risk assessment based on appropriate policy would only be unbalanced if you thought, first, you were behind the curve; second, if a shock came that was so large and sudden that the lags in monetary March 22, 2005 76 of 116 other. So, the question is: Is it news to put this clause in the paragraph? I guess I’d have to argue that it really isn’t, because how could you have been tightening six times off a risk assessment that was balanced, unless it was implicitly conditioned on appropriate policy. The suggestion in the Bluebook was to make that conditioning explicit because, at this particular point, it would emphasize that it takes some work to keep the risks balanced. But I did want to flag to you that if you go in that direction, at some point along that road you are not going to be happy with the statement." FinancialCrisisReport--315 CDOs.” 1231 The examinations reviewed CRA practices from January 2004 to December 2007. In 2008, the SEC issued a report summarizing its findings. The report found that “there was a substantial increase in the number and in the complexity of RMBS and CDO deals,” “significant aspects of the ratings process were not always disclosed,” the ratings policies and procedures were not fully documented, “the surveillance processes used by the rating agencies appear to have been less robust than the processes used for initial ratings,” and the “rating agencies’ internal audit processes varied significantly.” 1232 In addition, the report raised a number of conflict of interest issues that influenced the ratings process, noted that the rating agencies failed to verify the accuracy or quality of the loan data used to derive their ratings, and raised questions about the factors that were or were not used to derive the credit ratings. 1233 (2) New Developments Although the Credit Rating Agency Reform Act of 2006 strengthened oversight of the credit rating agencies, Congress passed further reforms in response to the financial crisis to address weaknesses in regulatory oversight of the credit rating industry. The Dodd-Frank Act dedicated an entire subtitle to those credit rating reforms which substantially broadened the powers of the SEC to oversee and regulate the credit rating industry and explicitly allowed investors, for the first time, to file civil suits against credit rating agencies. 1234 The major reforms include the following: a. establishment of a new SEC Office of Credit Ratings charged with overseeing the credit rating industry, including by conducting at least annual NRSRO examinations whose reports must be made public; b. SEC authority to discipline, fine, and deregister a credit rating agency and associated personnel for violating the law; c. SEC authority to deregister a credit rating agency for issuing poor ratings; d. authority for investors to file private causes of action against credit rating agencies that knowingly or recklessly fail to conduct a reasonable investigation of a rated product; e. requirements for credit rating agencies to establish internal controls to ensure high quality ratings and disclose information about their rating methodologies and about each issued rating; 1231 7/2008 “Summary Report of Issues Identified in the Commission Staff’s Examinations of Select Credit Rating Agencies,” prepared by the SEC, at 1. The CRAs examined by the SEC were not formally subject to the Credit Rating Agency Reform Act of 2006 or its implementing SEC regulations until September 2007. 1232 Id. at 1-2. 1233 Id. at 14, 17-18, 23-29, 31-37. 1234 See Title IX, Subtitle C – Improvements to the Regulation of Credit Rating Agencies of the Dodd-Frank Act. f. amendments to federal statutes removing references to credit ratings and credit rating agencies in order to reduce reliance on ratings; g. a GAO study to evaluate alternative compensation models for ratings that would create financial incentives to issue more accurate ratings; and h. an SEC study of the conflicts of interest affecting ratings of structured finance products, followed by the mandatory development of a plan to reduce ratings shopping. 1235 CHRG-111hhrg55811--333 Mr. Hill," Yes. I would agree with what has been said. I think the key thing here is that with respect to all the markets we have been talking about, interest rates, currencies, and the corporate credit default swap market, the underlying instrument on which the derivative was based was a relatively liquid and transparent market. For example, with respect to the corporate CDS market, the underlying corporate credits were typically 34 reporting companies. So people who are transacting in the corporate credit default swaps understood the risks they were taking because the underlying credits were reporting companies that had financials, had to file periodic reports as their material events changed, and therefore the corporate credit default swap market actually performed very, very well during the financial crisis. In fact, it was far more liquid and far more transparent than the bond market. The problem with the subprime credit default swap market was not with the credit default swap itself, but how the underlying instrument that people were basing their derivatives on-- " FOMC20080929confcall--4 2,CHAIRMAN BERNANKE.," I have three topics to raise with you today. First, financial market conditions, as you know, remain quite strained, and in response to that we are proposing some additional liquidity measures. Mostly this is informational. However, we are proposing to increase the swap lines fairly significantly, and although you have authorized the Foreign Currency Subcommittee to take those actions, we thought that, given the size of the change, it would be worthwhile to bring this back to you for your attention and your vote just to get the Committee's agreement on this issue. The second issue is Wachovia. As you may have heard, Wachovia was purchased, or there's a plan to purchase, by Citigroup this morning. To facilitate that purchase, the Board invoked the systemic risk exception, which has not been done before. So we want to give you a chance to catch up on what's going on there. Then third, we want to talk a bit about interest on reserves, which will be provided in the Paulson financial rescue bill, which is supposed to be up for a vote on Wednesday. I just want to brief you on what we're planning in that regard. So let me start by turning to Bill Dudley in New York. Bill, if you could give us a brief overview of the financial conditions that motivate these actions, review the actions we're proposing, and take Q&A, that would be very helpful. " CHRG-110hhrg46593--10 Secretary Paulson," Thank you very much, Mr. Chairman. Mr. Chairman, Congressman Bachus, and members of the committee, thank you for the opportunity to testify this morning. Six weeks ago, Congress took the critically important step of providing important authorities and resources to stabilize our financial system. Until that time, we faced a financial crisis without the proper tools. With these tools in hand, we took decisive action to prevent the collapse of our financial system. We have not in our lifetimes dealt with a financial crisis of this severity and unpredictability. We have seen the failures or the equivalent of failures of Bear Stearns, IndyMac, Lehman Brothers, Washington Mutual, Wachovia, Fannie Mae, Freddie Mac, and AIG, institutions with a collective $4.7 trillion in assets when this year began. By September, the financial system had seized up, presenting a system-wide crisis. Our objectives in asking Congress for a financial rescue package were to, first, stabilize a financial system on the verge of collapse and then to get lending going again to support American consumers and businesses. Over the next few weeks, conditions worsened significantly. Confidence in the banking system continued to diminish. Industrial company access to all aspects of the bond market was dramatically curtailed. Small- and middle-sized companies with no direct connection to the financial sector were losing access to the normal credit needed to meet payrolls, pay suppliers, and buy inventory. During that same period, the FDIC acted to mitigate the failure of Washington Mutual and made clear that it would intervene to prevent Wachovia's failure. Turmoil had developed in the European markets. In a 2-day period at the end of September, the governments of Ireland, the U.K., Germany, Belgium, France, and Iceland intervened to prevent the failure of one or more financial institutions in their countries. By the time legislation had cleared Congress, the global market crisis was so broad and severe that powerful steps were necessary to quickly stabilize our financial system. Our response, in coordination with the Federal Reserve, the FDIC, and other banking regulators was a program to purchase equity in banks across the country. We have committed $250 billion to this effort. This action, in combination with the FDIC's guarantee of certain debt issued by financial institutions and the Fed's commercial paper program helped us to immediately stabilize the financial system. The Capital Purchase Program for banks and thrifts has already dispersed $148 billion, and we are processing many more applications. Yesterday, Treasury announced the terms for participation for nonpublicly traded banks, another important source of credit in our economy. We have designed these terms to help provide community development financial institutions and minority depository institutions with capital for lending to low-income and minority populations. These institutions have committed to use this capital for businesses and projects that serve their communities. In addition, we are developing a matching program for possible future use by banks or nonbank financial institutions. Capital strength enables banks to take losses as they write down or sell troubled assets. Stronger capitalization is also essential to increasing lending, which although difficult to achieve during times like this, is essential to economic recovery. We expect banks to increase their lending over time as a result of these efforts and as confidence is restored. This lending won't materialize as fast as any of us would like. But it will happen much, much faster having used the TARP to stabilize our system. As we continue significant work on our mortgage asset purchase plan, it became clear just how much damage the crisis had done to our economy. Third quarter GDP growth showed negative three-tenths of a percent. The unemployment rate rose to a level not seen in 15 years. Home price status showed that home prices in 10 major cities had fallen 18 percent over the previous year, demonstrating that the housing correction had not abated. The slowing of European economies has been even more dramatic. We assessed the potential use of remaining TARP funding against the backdrop of current economic and market conditions. It is clear that an effective mortgage asset purchase program would require a massive commitment of TARP funds. In September, before economic conditions worsened, $700 billion in troubled asset purchases would have had a significant impact. But half of that sum in a worse economy simply isn't enough firepower. We have therefore determined that the prudent course at this time is to conserve the remaining funds available from the TARP, providing flexibility for this and the next Administration. Other priorities that need to be addressed include actions to restore consumer credit. Treasury has been working on a program with the Federal Reserve to improve securitization in the credit marketplace. While this would involve investing only a relatively modest share of TARP funds in the Federal Reserve liquidity facility, it could have substantial positive benefits for consumer lending. Finally, Mr. Chairman, Treasury remains committed to continuing to work to reduce avoidable foreclosures. Congress and the Administration have made substantial progress on that front through HUD programs, the FDIC's IndyMac approach, our support and leadership of the HOPE NOW Alliance, and our work with the GSEs, including an important announcement they made last week establishing new servicer guidelines that will set a new standard for the entire industry. Our actions to stabilize and strengthen Fannie Mae and Freddie Mac have also helped mitigate the housing correction by increasing access to lower-cost mortgage lending. As some on the committee know, I have reservations about spending TARP resources to directly subsidize foreclosure mitigation because this is different than the original investment intent. We continue to look at good proposals and are dedicated to implementing those that protect the taxpayer and work well. Mr. Chairman, the actions of the Treasury, the Fed, and the FDIC have stabilized our financial system. The authorities in the TARP have been used to strengthen our financial system and to prevent the harm to our economy and financial system from the failure of a systemically important institution. As facts and conditions in the market and economy have changed, we have adjusted our strategy to most effectively address the urgent crisis and to preserve the flexibility of the President-elect and the new Secretary of the Treasury to address future challenges in the economy and capital markets. Thank you again for your efforts and for the opportunity to appear today. I would like to just make one last comment in response to a question that Congressman Bachus asked because it is one I hear a lot, the distinction between the financial markets and the economy. So when we have talked about the crisis and the financial markets and being unprecedented and having to go back to the Great Depression to see anything of this magnitude and be presented with this amount of difficulty, we are talking about the financial markets. Now, when the financial markets have problems, they hurt the economy. So the reason that it was very important to get in quickly and stabilize it was to mitigate damage to the economy. When we were here before you, we saw what was happening to the economy. We talked about it. We took the steps. The economy has continued to get worse. The American people look at the worsening economy. And as your chairman said to me yesterday, in politics, you don't get much credit for what might have happened and didn't happen. What the American people see is what is happening to the economy. But again, our purpose in coming to you was to take-- " FOMC20071211meeting--92 90,MR. LACKER.," Thank you, Mr. Chairman. Economic conditions in the Fifth District appear to be generally sound but with some notable areas of weakness. Our survey readings on the services firms indicate continued moderate growth in November, and our index of manufacturing activity gained a few points following a sharp decline in October, though it remains in neutral territory. A number of our contacts reported that the weaker dollar is providing a boost to manufacturing exports, and I have noticed a definite increase in the number of coal trains rumbling by my office on their way from West Virginia to port. On the other hand, our merchant contacts were much less optimistic about their sales prospects going into the holiday season. Our retail sales survey indicator slid another 8 points, pulled down by significant declines in big ticket sales and shopper traffic components. District housing markets continue to weaken overall, with distinctly more-pessimistic tones in some markets, particularly around the D.C. area, although there are a couple of areas that are still reporting decent activity to the south. In commercial real estate, reports from the retail and industrial markets are generally upbeat. One former director, whose firm owns a sizable portfolio of retail properties throughout the East Coast, described the sector as in the best shape he has seen in his lifetime, and he is by no means a young man. Industrial leasing appears to be in good shape, even tight in some markets. In the office market, however, contacts in Maryland and the Carolinas report slower office leasing activity in October and early November. The community bankers I have talked with say that portfolios are still quite clean but that they are scrutinizing deals much more carefully in the current environment. They also complain that large banks are raising deposit rates and competing more intensely for deposits. At large banks, the cost of capital has increased, and they are responding accordingly by reevaluating the profitability of various lines of business. This does not appear to have resulted in any wholesale cutback in lending but more in a tightening of terms in selected market segments. I view the information from our District as fairly consistent with my economic outlook at the national level. Housing investment continues to contract, and the overhang of unsold homes and general tightening of credit terms suggest a quite prolonged period of relatively depressed activity. Consumer spending clearly has slowed. For the months of September and October, real consumption showed almost no growth. While early reports on the holiday shopping season are notoriously slippery, it seems clear that shoppers are far from ebullient, perhaps with the exception of these GPS toys. This seems consistent with the virtual absence of growth in real disposable income over the past two months and the flattening-out of household net worth in the third quarter. Job growth has shifted down to a more modest pace over this year, and revisions to the payroll series, when we finally get them, seem likely to make the slowdown look bigger. So it wouldn’t surprise me if consumer spending came in fairly tame next year. I am expecting a slowdown in consumer spending growth, however, not a sharp pullback. Labor markets are still fairly tight. Household net worth is still at fairly elevated levels. So while the increase in the saving rate projected by the Greenbook for next year is plausible, I think consumer spending could come out on the high side of that forecast. A key factor in the outlook and a key source of uncertainty is the continuing drama in credit markets. Large banks are bringing impaired assets onto their balance sheets and are facing a higher cost of capital and increased funding costs. It would seem reasonable to expect them to respond by tightening terms of credit for households and business borrowers, implying a further drag on spending. The magnitude of this sort of fallout is still quite uncertain. Reduced credit flows appear so far to be less a reduction in credit supply than in demand. That is, they appear to reflect a genuine deterioration in borrower creditworthiness in some segments. Residential real estate fits this description as does some, though not all, commercial real estate. Beyond these sectors, we have seen some evidence of yield spreads widening, but the cost of credit to investment-grade nonfinancial firms is low and has been falling along with the risk-free rate, at least until very recently. The flow of credit to such firms seems to have been holding up well, as has the nonmortgage consumer credit flow. So at this point, it does not look as though an indiscriminate, across-the-board credit crunch is taking place, although marginally higher credit costs may exert some additional drag on spending growth. Overall, then, I do see a weaker outlook for growth in the near term, and the timing of the return to trend is going to depend somewhat on the bottoming-out of the housing cycle, which unfortunately appears to be getting even more remote each time we meet. If we have a more protracted slowdown ahead of us, as seems likely now, we need to be careful not to lose sight of inflation. Core PCE inflation has edged up over the past two months, and it now appears likely to move above 2 percent for a time. Overall inflation, of course, has been higher on average over the last year, and we have seen a slight upward trend in five-year- forward inflation compensation since earlier in the year. In fact, the behavior of energy and food prices over the past several years calls into question the standard presumption we make that overall inflation is going to return to the core inflation trend in a reasonable period of time. That points to the possibility that inflation may give us more trouble ahead." CHRG-111hhrg58044--66 Mr. Wilson," I do think some of the comments that were introductory to this session are accurate, that not every consumer has a clear understanding of all of the details of credit reports, credit scoring, or how these things are used in making decisions about them. I do think we have tried to be out there making information available to consumers. We developed training programs for continuing education credits for agents, insurance agents, because they are very often the first line of answering questions about these things. " CHRG-111shrg62643--230 RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER FROM BEN S. BERNANKEQ.1. Chairman Bernanke, I am deeply disturbed by the most recent quarterly report to Congress from the Special Inspector General for the Troubled Asset Relief Program. In this report, SIGTARP Neil Barofsky tells Congress that reductions in current outstanding balances of TARP and TARP-related programs ``have been more than offset in the past 12 months by significant increases in expenditures and guarantees in other programs, with the total current outstanding balance increasing 23 percent, from approximately $3.0 trillion to $3.7 trillion. This increase can largely be attributed to great support for the Government-sponsored enterprises (GSEs), the housing market, and the financial institutions that participate in it'' despite the fact that the banking crisis, by an reasonable measures, subsided. How long do you perceive a need for extraordinary taxpayer support for the housing market?A.1. As your question suggests, declining balances in, and closing of, some financial-sector support programs are positive developments that are indicative of a gradual healing in the financial system. The stock of other assets acquired by the Federal Government related to extraordinary support of the financial system has increased significantly over the past year, including purchases of Treasury, agency, and agency-guaranteed mortgage-backed securities under the Federal Reserve's large scale asset purchase program, and purchases by Treasury of preferred shares in Fannie Mae and Freddie Mac as those GSEs continue to operate in conservatorship. Other housing-related guarantees, commitments, and outlays by the Government have also grown significantly over that period, although some are probably better understood as reflecting extraordinary conditions in the housing finance market more than extraordinary actions to support the financial system. In particular, mortgage loans and mortgage-backed securities guaranteed by FRA and the GSEs have continued to rise substantially, as the private-label mortgage securitization market remained essentially closed. The programs described above, along with continuing low mortgage interest rates and the effects of the first-time homebuyer tax credit, have helped support housing market conditions and thus to blunt some of the damage of the financial crisis. Nonetheless underlying weaknesses remain in the housing and home finance markets. As noted in my testimony, for example, housing construction has continued to be weighed down by weak demand, a large inventory of distressed or vacant houses, and tight credit conditions for builders and some potential buyers. For their part, RAMP and non-RAMP foreclosure mitigation loan modification programs have made a positive contribution, reducing debt service obligations for many struggling borrowers. Over the longer horizon, it remains too early to assess the overall effect of these programs, including the extent to which borrowers with RAMP permanent modifications, or other loan modifications and refinancings, may subsequently default on these obligations. As economic and financial conditions gradually improve, the extraordinary conditions and need for extraordinary Government actions will of course diminish. When that time comes, as with the Federal Reserve's purchases of agency-guaranteed mortgage-backed securities, the withdrawal of extraordinary support should be managed carefully so that it can be achieved with a minimum of associated dislocation. Congress has a direct/public policy role to play in some aspects of this eventual withdrawal, including as it considers the future role of Government-sponsored enterprises in the market for housing finance. The non-TARP program estimates published in SIGTARP reports are assembled directly by SIGTARP staff across non-TARP programs they deem relevant, drawn from public sources. Without speaking directly to the figures you reference, the SIGTARP estimates cited in your question can reasonably be interpreted as consistent with this assessment.Q.2. Chairman Bernanke, you have indicated that the Federal Reserve may undertake additional asset purchases. What kind of assets will the Fed purchase if it decides to undertake a second quantitative easing? How will you ensure that the Federal Reserve adequately protects itself in pricing those asset purchases and how long would the Fed hold those assets on its balance sheet? What metric will you use to determine that additional easing is necessary?A.2. Consistent with its statutory mandate to foster maximum employment and stable prices, the Federal Reserve would consider additional steps to provide monetary accommodation if economic developments suggested that it was appropriate to do so. As noted in the minutes of recent FOMC meetings and in speeches by Federal Reserve officials, purchasing additional assets would be one of the options that the Federal Reserve could implement in such a situation. The Federal Reserve's legal authority largely limits Federal Reserve purchases of securities to Treasury, agency, and agency-guaranteed securities. As a result, additional Federal Reserve purchases of securities, if deemed necessary, would likely be of these general types. Decisions about the specific securities that would be purchased within this general class of securities would depend on a number of factors, including the implications of purchases for the general level of longer-term interest rates, the effect of purchases on market liquidity and functioning, and policymakers' preferences for the long-run composition of the Federal Reserve's balance sheet. As in the past, the Federal Reserve would employ a competitive bidding process in purchasing securities to ensure that such purchases are conducted at market prices. The evidence suggests that the Fed's earlier program of purchases of securities was effective in improving market functioning and lowering long-term interest rates in a number of private credit markets. The program (which was significantly expanded in March 2009) made an important contribution to the economic stabilization and recovery that began in the spring of 2009. Indeed, the FOMC's recent decision to keep constant the Federal Reserve's securities holdings reflects the conviction that these holdings can promote financial conditions that help support the recovery. Decisions regarding how long these assets or any newly acquired assets will be held on the Federal Reserve's balance sheet will be based on an assessment of the outlook for economic activity and inflation. There are no simple metrics that the Federal Reserve can employ in determining whether additional policy easing is necessary and, if so, whether additional purchases of securities would be appropriate. As always, a wide range of economic indicators informs the Federal Reserve's view about the outlook for economic activity and inflation. Any decision to acquire additional securities would need to weigh the potential benefits of such purchases against the potential costs. Regarding potential benefits, additional purchases could further lower the costs of borrowing for households and businesses and thereby provide needed support for spending and economic growth. On the other hand, further purchases of securities could reduce public confidence in the ability of the Federal Reserve to exit smoothly from a very accommodative policy stance at the appropriate time. Even if unjustified, a reduction in confidence might lead to an undesired increase in inflation expectations and so to upward pressure on actual inflation. The Federal Reserve will weigh these and other considerations and carefully monitor economic and financial developments in judging whether additional asset purchases are warranted.Q.3. A number of economists, market watchers and Members of Congress have speculated that U.S. firms are reluctant to invest and hire, though they may have the cash on their balance sheets to do so, because of uncertainty over a dramatic reshaping of the health care and financial regulatory regimes. How large of a role do you believe this uncertainty is playing in companies' decisions on how and when to deploy their capital? And, do you think the uncertainty over future tax rates also factors in?A.3. Several factors are likely to influence hiring and capital spending decisions. Typically, a firm's sales prospects and the expected rate of return to an investment--either in new equipment or new workers--are key elements in the decision. In some cases, access to credit also might affect decisions to invest and hire. In addition, uncertainty about the economic environment or expected returns can also influence the willingness of a firm to make spending commitments. Recent surveys of businesses provide some insights into these issues and suggest that many firms are concerned about the overall economic environment and their company's own sales prospects. Two examples are presented in the table. As shown on line 1, 36 percent of respondents to the latest Duke CFO survey cited consumer demand as the most important problem facing their business. Fortunately, concerns about consumer demand have diminished from a year ago, but they remain the most frequently cited problem. Similarly, as shown on line 3 of the table, respondents to the latest survey of small businesses, conducted by the National Federation of Independent Business (NFIB), pointed to poor sales as their most important problem, but that concern also has diminished from a year ago. In addition, the S&P 500 volatility index (VIX), an indicator of uncertainty in financial markets, also is down from its previous peaks, although it remains relatively elevated by historical standards. It is difficult to know the extent to which uncertainty specifically related to future taxes, the recently enacted health care legislation, or financial regulatory reform is affecting business capital spending and hiring decisions. However, both the Duke CFO survey and the NFIB allow respondents to cite government policies more generally as the most important problem facing their business. These responses are shown on lines 2 and 4 of the table. In addition, line 5 presents the data on the extent to which taxes are a pressing business concern. Of course, these responses are not direct indicators of uncertainty. Moreover, the figures presented in the table are from only two surveys and may not present a complete picture of whether greater uncertainty about Government policies is restraining capital spending and hiring.Q.4. Are you concerned that keeping interest rates this low, for such an extended period of time, will have negative or dangerous consequences? Why, or why not?A.4. The FOMC has established a very low level of short-term interest rates to foster its statutory objectives of maximum employment and stable prices. The FOMC has been very explicit in stating that the current very accommodative stance of monetary policy is conditional on the economic outlook, which includes low anticipated rates of resource utilization, subdued inflation trends, and stable inflation expectations. The explicit conditionality of the Federal Reserve's policy stance should help to guard against adverse outcomes such as a buildup in inflationary pressures or imbalances in financial markets. As the economy recovers, investors, seeing that the conditions supporting the current stance of policy have changed, will likely begin to anticipate the removal of policy accommodation; such anticipations of policy firming will, in turn, boost longer-term interest rates immediately, helping to damp any buildup in inflationary pressures. Of course, the Federal Reserve must be able to validate expectations of policy firming at the appropriate time. To do so, the Federal Reserve has a number of tools at its disposal. First, the Federal Reserve will put upward pressure on short-term interest rates by raising the rate it pays on the reserve balances held by depository institutions. Second, the Federal Reserve has developed reserve draining tools that can be employed to reduce the quantities of reserves outstanding and thereby tighten the relationship between the rate paid on reserve balances and short-term market rates. Finally, the Federal Reserve can sell assets at an appropriate time and pace to further tighten the stance of monetary policy. In short, the Federal Reserve has the tools necessary to effectively remove policy accommodation when such actions are warranted by the economic outlook. As always, the Federal Reserve is sensitive to the risks surrounding the outlook, and we are mindful of the possibility that very low interest rates could, if maintained for too long, lead to adverse economic outcomes. At the same time, there are risks that the premature removal of policy accommodation could undermine the economic recovery and contribute to unwelcome disinflationary pressures. The Federal Reserve will be monitoring economic and financial developments carefully to ensure that its policy actions appropriately balance these risks. ------ CHRG-111shrg56376--35 Mr. Tarullo," Thank you, Senator. If you are asking, what should the public be focused on, my suggestion would be too big to fail. That is not the only problem by a long shot, but to me, it continues to be the central problem--the ability to avoid the moral hazard that comes with ``too-big-to-fail'' institutions. As I said a moment ago, I think we need a variety of supervisory and regulatory tools to contain that problem, whether it is resolution, bringing systemically important institutions into the perimeter of regulation, making sure that the kinds of capital and liquidity requirements that systemically important institutions have will truly contain untoward risk taking. I think we are going to need a broad set of activities. ``Too big to fail'' was not the only cause, but it was at the center of this crisis and that is, I think, what we all need to focus on. The only other thing I would say harks back to a colloquy you and I had a couple of weeks ago when I was testifying. You and I were talking about attitudes and orientation and how people in the Congress and the regulatory agencies and the Administration think about issues and problems. It is not easy to ensure against people losing interest in issues. But I think that is a role that, in a system of Government that has a lot of checks and balances, we have to think about. How do we try to institutionalize skepticism and critical thinking, to look at developments in the financial world so that we don't just say, well, that is just another market development; it must be benign. But instead, we must begin to distinguish intelligently between benign, useful innovations on the one hand and building problems on the other. Senator Brown. Thank you. " Mr. Bowman," " CHRG-111hhrg58044--80 Mr. Snyder," Congress continued the ability of insurers to use credit information for insurance underwriting, and that has long been the case. Congress continued that through the recent amendments. The recent amendments also made the whole credit scoring system better. Frankly, we have a major interest in making sure that scores are accurate and that people have access to their credit history and the ability to correct any issues that may exist. I think the Congress improved all of that through the most recent amendments, but did maintain the long-standing ability on the part of insurers to use credit for underwriting subject to Federal law under the Fair Credit Reporting Act, and all that implies as well as being currently State regulated, all the State regulation that applies as well. " FOMC20051101meeting--3 1,MR. KOS.,"1 Thank you, Mr. Chairman. The now lengthy period of tight spreads and low volatilities continued in the intermeeting period. That was despite some unexpected credit events, another hurricane, and increased talk about upside inflation risks. The top panel on page 1 graphs the 3-month deposit rate in black and the same rate three and nine months forward in red. The 3- and 9-month forward rates rose 47 and 53 basis points, respectively, as market participants absorbed incoming data and, even more, comments by Committee members expressing heightened levels of concern about upside inflation risks. Many market participants now assume that the Committee will tighten during each of the next four meetings, including the first meeting to be presided over by the new Chairman. The tone of market expectations—at least among traders as opposed to Street economists—has changed a bit. Earlier this summer the betting was about where the co-called “neutral” rate resides. The assumption was that the Committee would stop in that neighborhood. Now, with increased concern about inflation, the question of where neutrality resides is slowly being superseded by a new question: How far beyond “neutral” will policy need to go to dampen inflationary pressures? The yield curve rose across maturities, as shown in the middle panel. The 2-year Treasury yield rose 40 basis points while the 10-year yield rose 30, apparently affected in part by MBS-related hedging flows. The 2-year yield is at its highest level since May 2001. The shape of the curve narrowed by 10 basis points and sits at a relatively narrow 17 basis points. November 1, 2005 4 of 114 changed, as seen in the bottom panel. The 2-year break-even inflation [BEI] rate had risen over the summer as energy prices rallied; but it plateaued and came off a bit as the price of oil headed back down. The 10-year BEI was little changed. This suggests that the rise in nominal yields was an increase in real rates and suggestive of tightened financial conditions. The sluggishness in equity markets until this past Friday was consistent with this view. The behavior of break-even rates also calls into question some of the instant analysis surrounding Ben Bernanke’s nomination last Monday. While some analysts were quick to attribute the rise in nominal yields last week to the nomination—on the basis of some perceived squishiness on inflation—the rise in real yields, which had already been in train, and the flatness of BEIs do not bear this out. If there is some suggestion that financial conditions are tightening, the evidence elsewhere was mixed. Certainly, yields in other major economies have been moving higher since the end of the summer, as shown in the top panel of page 2. Long-term sovereign yields in the U.K., Canada, and Germany—the latter as a proxy for the euro area—have been rising recently. The rise of nearly 40 basis points in German yields has been particularly noteworthy and may reflect upgraded forecasts for European growth in general and improved sentiment toward Germany, notwithstanding a messy election outcome that leaves prospects for reform uncertain. Even Japanese yields have been rising recently. Investors are increasingly contemplating that maybe, just maybe, after so many false starts, this time the recovery is for real. The better economic tempo and heightened probabilities that sometime in the next 12 months the CPI will no longer be preceded by a negative sign are leading more investors to take a defensive posture toward Japanese bonds. Expectations about near-term policy in those same countries are broadly consistent with the movement in longer-dated yields. The middle panel graphs March 2006 futures prices for short-dated interest rates for the U.S., U.K., Canada and the euro area. Short sterling futures are flat—in itself noteworthy, given that the Bank of England most recently eased policy. The others are all moving upward to varying degrees. The middle right panel graphs the December 2006 euro-yen deposit futures contract, which has also risen as the market tries to anticipate the end of the Bank of Japan’s [BOJ] quantitative easing policy, now expected by the market—and the BOJ, as reported in the monthly report yesterday—to be sometime in the fiscal year beginning on April 1. November 1, 2005 5 of 114 have both been able to ease monetary policy—albeit from high levels—in recent days and weeks, as reflected in the bottom panels. Brazil and Colombia have managed to issue local-currency-denominated debt in the international market at attractive rates, as have some private borrowers in Asia. This decoupling from policy rates in the major economies stands in sharp contrast to previous cycles. And to emerging market bulls, it reflects a better policy mix, higher reserves, and a strong global economy. As with emerging markets, the byword in domestic credit markets seemed to be “what, me worry?” Despite some high-profile bankruptcies in airlines, auto parts, and the surprise collapse of Refco, credit markets were not flustered and took the news in stride. As shown in the top panels on page 3, both investment- grade and high-yield spreads moved only slightly and remained at historically tight levels. The bankruptcies of Delta and Northwest were dismissed, having been long expected. The Delphi bankruptcy was also broadly expected. And yet when it happened, protection for General Motors in the CDS [credit default swap] market temporarily shot higher, as shown in the middle panel. The prospect that GM might have to absorb billions of dollars of additional pension costs got traders’ attention. Ford Motor CDS rates were also affected. But the broader Dow Jones CDX high-yield index—comprised of 100 single names—was little changed. One collapse that was not expected was that of Refco, whose fraud was made public the morning of October 10 and which filed for bankruptcy on October 17. Refco is a small corporate bond issuer but it does have linkages to firms across Wall Street. All in all, the stress emanating from Refco was limited. The rather busy graph at the bottom of page 3 depicts credit default swap rates for eight major financial firms since January. Note the temporary increase in the price of protection for these firms in the spring, when GM and Ford were downgraded and the so-called “correlation trades” began to go bad. In contrast, the Refco news did not even register a blip in CDS rates. Overall, markets are posing something of a puzzle. The rise in real yields and the fall in equity prices for most of September and October suggest a tightening of financial conditions. There were both expected and unexpected bankruptcy filings. Yet both emerging markets and domestic credit markets were unfazed, and money continues to seek higher-yielding assets. Maybe it really is different this time. Then again, maybe the reaction will come with a lag that is longer than usual. November 1, 2005 6 of 114" FOMC20071031meeting--214 212,MS. DANKER.," I will start with the directive from the Bluebook. The language is as follows: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 4½ percent.” Then the statement, which I will not read in its entirety, is as written under alternative A in the revised October 31 table that was handed out. Chairman Bernanke Yes Vice Chairman Geithner Yes President Evans Yes President Hoenig No Governor Kohn Yes Governor Kroszner Yes Governor Mishkin Yes President Poole Yes President Rosengren Yes Governor Warsh Yes" FOMC20081029meeting--203 201,MR. LOCKHART.," Thank you, Mr. Chairman. Most of the anecdotal information from the Sixth District is consistent with the downbeat picture that has been emerging in the national data. The sentiment of directors and their contacts has turned decidedly more pessimistic regarding current economic conditions and the near-term outlook. Banking contacts indicate a further tightening of credit standards, while stresses on household and small business finances have resulted in increased credit card usage. A state economic-development official noted that some banks have halted their 90/10 SBA lending. Bankers active in the VRDN (variable rate demand note) market noted that municipalities are under pressure with declining revenues and higher financing costs. Nonresidential building contractors noted a large increase in the number of canceled projects. Advisory council members described a substantial decline in domestic shipping and transport activity for most goods, other than energy products, and some slowing of export volumes through regional ports. Finally, retail contacts, in anticipation of the coming holiday season, noted that orders are down, and heavy price discounting has begun already. Thematically, Atlanta's forecast is consistent with the Greenbook, but we are projecting a slightly more severe and protracted downturn in business activity than the Greenbook baseline. My assumption is that the cascading dynamic at work in the financial markets may take longer than projected in the Greenbook to come to an end. As a consequence, I view the Greenbook's scenario entitled ""more financial fallout"" as the most plausible storyline among the likely range of outcomes. I should acknowledge that we're in an interval between the announcement of the TARP and its full implementation. The encouraging improvement in credit spreads and term funding we have seen in recent days may accelerate once the TARP is operational. With inflation abating more or less as expected and with such uncertainty surrounding the playing out of continuing and recently worsening turmoil in the financial markets, I have to view the balance of risks as more negative for growth than upside for inflation. Thank you, Mr. Chairman. " CHRG-111hhrg58044--152 Mr. Hinojosa," I am glad to hear you say that. Mr. McRaith, do lenders or insurance lenders pay for the credit reports they obtain from the credit reporting agencies? " CHRG-111hhrg55809--64 Mr. Bernanke," Well, there has been some research in the Fed system and elsewhere trying to lay out criteria. But to some extent, there would have to be a set of principles that the Congress would enumerate in terms of what we would be looking at. One of the issues is that which firms are systemically critical may depend to some extent on the state of the broad economy. So, for example, it might have been possible to let certain firms fail if the rest of the economy had been in a healthy condition and the financial system in a healthy condition. But in a situation where we are in a panic and a recession and so on, that may lower the bar in some sense. So I can't give you precise numbers. I do think we would owe the Congress some careful studies of what the considerations would be, recognizing that they might change over time depending on the state of the economy and the state of the financial system. Ms. Velazquez. Thank you. " CHRG-111shrg57322--589 Mr. Broderick," Thank you, Chairman Levin, Ranking Member Coburn, and Members of the Subcommittee. Good afternoon. My name is Craig Broderick. I have been the Chief Risk Officer of Goldman Sachs since 2007 and prior to that was the Chief Credit Officer. I am responsible in this capacity for credit, market, operational risk, and insurance.--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Broderick appears in the Appendix on page 221.--------------------------------------------------------------------------- In summarizing my written submissions, I will focus my remarks on the firm's risk management framework to supplement David Viniar's comments on the topic and look forward to addressing your questions in more detail. As noted by Mr. Viniar, the nature of our role as financial intermediary requires a willingness to take risk on behalf of our clients. We seek to do so only within very carefully calibrated limits which are in line with our overall financial resources. Our clients expect us to facilitate transactions for them in all market conditions, and as such, the better that we understand and can manage risk, the more willing we are to transact with clients regardless of our views on markets. Our risk management framework has a number of core components. The central tenet is our daily discipline of marking all the firm's financial assets and liabilities to current market levels. We do so because we believe that it is one of the most effective tools for assessing and managing risk, providing the best insights into our positions and associated exposures. Goldman Sachs, as Mr. Viniar noted, is one of the few financial institutions in the world that carries virtually all financial instruments held in its inventory at current market value, with any changes reflected immediately in our risk management systems. The second core component is independence. Professionals in our risk management and key control functions have complete independence from their counterparts in the revenue generating divisions. This uncompromised independence, which exists in practice as well as in concept, gives teeth to the firm's risk management approach. The third is governance. The firm's governance structure provides the protocol and responsibility for decision making and implementation on risk management issues. A fourth component is our use of risk systems. We have developed and employed robust technology to track a variety of risk metrics across all the firm's trading businesses. And finally, our limit structure. The firm applies a rigorous limits framework to control our risk across multiple trades, products, businesses, and markets. These limits are monitored on a daily basis and they serve to maintain and promote constant dialogue between our traders and our risk managers, as well as the escalation of risk-related matters. Taken together, these core elements enable us to make informed decisions on a real-time basis about the risks we are taking and to rapidly attempt to make adjustments when necessary. We employ a variety of risk metrics and measures. In the case of market risk, value at risk (VaR), and Credit Spread Widening are frequently referenced. Both are highly useful, but both suffer from limitations as, in fact, do all risk metrics, which is why we apply multiple measures to assess the overall risk in our portfolio. These limitations can show up especially acutely during abnormal market conditions, such as characterized the 2007 through 2008 period. For example, VaR is highly dependent on market volatility of the underlying trade or product, and during 2007, volatility reached unprecedented levels in some products, in particular, in subprime mortgages. This had the effect of increasing our mortgage-related VaR by many multiples, despite the underlying portfolios in many cases actually decreasing. Between late 2006 and February 2007, daily VaR in the Mortgage Department increased from $13 million to $85 million. We estimate that much of this increase was the result of increases in volatility, as our underlying positions in many cases declined. Accordingly, an accurate assessment of the level and direction of risk in our mortgage business was and is a matter of expert judgment, with the ultimate validation coming only after the fact when we could see how the actual portfolio moved in response to market conditions. While we were relatively successful in flattening our risk, it involved a process of continual portfolio adjustments and interpretations. For example, during much of 2007, our VaR showed that our overall portfolio risk was increasing and reflecting a short position, whereas our Credit Spread Widening measures showed the opposite in terms of direction. During such periods, it was ultimately the experience of our business and risk management professionals and their appreciation for the nuances of each of these measures that helped guide the firm in assessing its exposures and maintaining risk within prudent levels. Particularly in light of events in the last 2 years, it is clear that no approach to risk management was foolproof and we have all learned valuable lessons from the recent experiences. However, we do believe the core elements that make up our risk management framework are broadly effective, despite the unprecedented turmoil in the markets. Thank you, and we look forward to answering any questions you may have. Senator Levin. Thank you very much, Mr. Broderick. Mr. Viniar, Goldman Sachs issued a public statement, Exhibit 161,\1\ this past weekend which said that ``Goldman Sachs did not take a large directional `bet' against the U.S. housing market, and the firm was not consistently or significantly net `short the market' in residential mortgage products in 2007 and 2008.'' Our investigation focused on 2007, when the bubble burst, were you significantly net short in the market in residential-related products in 2007?--------------------------------------------------------------------------- \1\ See Exhibit No. 161, which appears in the Appendix on page 985.--------------------------------------------------------------------------- " FOMC20071031meeting--200 198,MR. WARSH.," Thank you, Mr. Chairman. Let me be the most recent but, I guess, not the last to say that this is a close call. I suppose I take more comfort in that than some around the table because I am pleased at the progress though it is not perfect and we’re not even back to an honest view of normal in the financial markets. That it’s a close call suggests to me that the data in the financial markets are normalizing. I guess the alternative of a close call would have been to have this be an easy call, and I suspect that the only way this would have been an easy call would be if we continued to have bad data and bad sentiment in the market. So I think we’re in the realm of a close call and we shouldn’t completely rue that situation. Again, that’s probably a function of the resilience of the economy, the resilience in the markets, some time and patience, and maybe even a little good monetary policy. So I’m okay with that, I think. The judgment that we make on moving or not moving ¼ percentage point today matters, but it strikes me as being considerably less important than what the future path of policy is expected to be in the capital markets. So I think that the most important judgment we make is in the fourth paragraph rather than the first paragraph. Let me spend a moment on what the financial markets are telling us with a degree of certainty which, speaking for myself, is quite surprising. Again, I think they have responded to real data over the past couple of weeks. They haven’t changed their probabilities based on utterances from the Chairman or from any of us, and I take some comfort in that. I might disagree with what they’re saying, but I don’t think that they’re just giving us a mirror image of our own views. So I take what they’re saying and the certainty with which they have taken on board that we’re going to move today. It’s not determinative. It’s not dispositive, nor should it be, but the debt capital markets, at least, think that the economy is worse—worse than the Greenbook and worse than many of us feel. Again, I would say that I have to take that on board without giving it too much predictive capability. I think that Brian is right—given the fragility in the financial markets and given the surprise that we had for them last time, I wouldn’t want our judgments today to add to that volatility, which I think would be quite possible. In sum, I would say that I support alternative A as written on this revised page. I think that, absent having strong language in alternative A, section 4, it would look to some as though the markets dictated this outcome. I think A-4 and robust balance of risk language is important so that the markets don’t believe incorrectly that we succumb to what their wants are. I think that previously, including at our last meeting, when we spoke about uncertainty, they seemed to understand what that was—that it wasn’t that we’re just calling it uncertainty but we really have cuts ahead. For better or for worse, they’ve now learned a lesson. Uncertainty with even pretty good data led us to cut this time, if we end up adopting alternative A. So if we use that same uncertainty language, I don’t think it would have the effect that it had last time of letting folks be on both sides of the bet on whether we would have continued actions. So I’m comfortable with alternative A, paragraph 4. It is a way of addressing market expectations and addressing our uncertainties by insurance, but being very clear to the markets that they ought not prejudge nor have we prejudged the outcome next time. The references to inflation risks there and in alternative A, paragraph 3, are useful to address some of the broader concerns we have about commodities and the foreign exchange value of the dollar. So with that, I think that alternative A is the right thing to do and that it does preserve for us plenty of ability to call it as we see it when we meet next. Thank you, Mr. Chairman." FOMC20080318meeting--101 99,CHAIRMAN BERNANKE.," Thank you very much. Thank you for all of your comments. Let me just briefly summarize and add a few points. To summarize the discussion, incoming data have been weak, and some view the economy as having entered recession. Housing demand and construction have continued to decline sharply, and house-price declines have been somewhat greater than expected. Housing weakness has implications for employment, for consumer spending, and for credit conditions. It also leads to 21 miles of empty boxcars. [Laughter] Financial conditions have worsened considerably, reflecting weakness in housing prices, and credit markets in particular are highly stressed and illiquid. Wider spreads have offset some or all of the decline in safe rates for many credit products, and credit conditions are tighter for most borrowers. Financial conditions are likely to be a significant drag on economic growth. Some noted the risk that continued financial turmoil could lead to a more serious and prolonged recession, implying possibly large downside risk to growth. With respect to households, consumption growth has flattened out, and there was generally greater pessimism about the labor market and economic prospects. Consumer credit quality may be worsening. Payroll employment growth has turned negative. There was little expectation expressed of strong help from the fiscal stimulus package. Firms are generally more pessimistic and cautious but also remain concerned about cost pressures. Inventories look to be in balance. Exports continue to be an important source of final demand and will continue to contribute significantly to growth, although it's possible that growth abroad may slow. Readings on core inflation have been mixed. Increases in energy and commodity prices are important sources of increased headline inflation, and some producers have adopted a cost-plus mentality. Agricultural prices, in particular, are up a good bit. Inflation breakevens are up somewhat, especially at the five-by-five horizon. The dollar has depreciated, potentially adding to longer-term inflation pressures and adding some risks. However, nominal wage increases are moderate, as are unit labor costs, and U.S. and global economic weakness could moderate gains in commodity prices and create domestic economic slack. Several members warned about the risk of losing inflation credibility. Any comments, thoughts? Let me make just a few comments. Again, I'm very sympathetic to what almost everyone has said around the table, in particular the fact that we're facing a three-front war, if you will, which makes this extraordinarily difficult and delicate. I thought in January that we were in recession. That was my view at that time, and I certainly believe it now. The Greenbook has done a good job of trying to factor in the data and the other types of evidence. I think I'm actually slightly darker on growth than the Greenbook is. The reason is that I don't see where the recovery is coming from in the beginning of next year. In particular, we won't have a recovery until financial markets stabilize, and the financial markets won't stabilize until house prices stabilize, and there is simply no particular reason to choose a time for that to happen. So I do think that the downside risks are quite significant and that this so-called adverse feedback loop is currently in full play. At some point, of course, either things will stabilize or there will be some kind of massive governmental intervention, but I just don't have much confidence about the timing of that. I would like to say a word. I would just agree with Governor Mishkin about the efficacy of our policy. I think that it has had an effect and it has been beneficial. We obviously affect shortterm rates, including commercial paper rates and the like, which have implications for financing and for borrowing. We affect the dollar, which has mixed effects, but on the growth side has some positive effects. It's true, as President Fisher pointed out, that medium-term and long-term rates have not fallen because lower Treasury rates have been offset by higher spreads, but again, the question is the counterfactual. Where would we be if we had not lowered rates? I think that lower rates have both lowered safe rates and offset to some extent the rising concerns about solvency, which have caused the credit spreads to widen. I think this argument can go either way. You can say that our policy is less effective and, therefore, we should do more of it. So there are two ways of looking at that. In addition, there may be some benefits for capital formation of low financing rates and a steep yield curve in keeping bank share prices from entirely collapsing. On inflation, I agree with much of what's been said, and I'm very concerned about it. Let me make one simple point, though, which I don't think has been adequately discussed. Ninety-five percent of the inflation that we're seeing is either the direct or the indirect effect of globally traded commodity prices--food, energy, and other commodities. What is happening is that there is a change in the relative price of, say, oil and the wage of an Ohio manufacturing worker. There's a relative price change going on. That has to happen one way or the other. It can happen either by overall increases in the nominal price of oil, which are reflected in overall increases in headline CPI inflation, or by lower or negative growth in nominal wages. Now, if we have temporary movements in these relative prices, I think all the theory tells us that the best way to let that relative price change happen is to let the shock feed through; let the prices of energy, commodities, and so on rise; accept a temporary increase in headline inflation; and focus on making sure that the increase in headline inflation doesn't feed through into domestic core inflation, say, through wages or domestic prices. A good response to that is, well, we've had a lot of ""temporary"" shocks here and they have gone on for a long time. That's certainly true. But again, it was very difficult to anticipate how these prices have moved. Looking forward, the futures markets have been wrong and wrong, but they are the best we have. In my view, if we think about the likely slowdown in the U.S. economy and the global economy, there are going to be some forces that will prevent commodity prices from continuing to rise the way they have been rising, which ought to take the pressure off the inflation process. That being said, I fully recognize that there has been a bit of movement in some of the indicators. I think I like the use of the index measure. It uses lots of different indicators. I don't think we should overemphasize inflation compensation. For example, the one-year inflation compensation three and four years out has moved up less than the five-by-five, and I think for good reasons. The five-byfive could reflect, again, general uncertainty. It could also reflect more volatility in the relative price changes of oil, for example. If we think there's more volatility in that, if it's up or down, that would create more uncertainty about headline inflation and would feed through into that spread. Frankly, in thinking about inflation, I am concerned about inflation expectations and the general psychology. I'm hopeful at least that it will moderate as commodity prices moderate although, of course, no one can know for sure. I agree with Governor Warsh that, from a financial perspective on the inflation side, the greater dangers are in the currency area. Exchange rates are very poorly tied down by fundamentals, except over very long periods of time--I think Ken Rogoff had a paper in which he said that over maybe 600 years or so the PPP finally works. [Laughter] So a lot of psychology is there. I think that it is an important issue. We need to think about what the Treasury will say and those sorts of things. That is a concern, and I consider that in some sense a greater risk at this point. So there are risks on both sides. I think that the downside risks, including the financial risks, at this point are greater--not to belittle inflation risks, which I think are quite significant. We are obviously going to have to make tradeoffs about how to deal with these. Using both our policy tools and our communication is very important. I agree with Vice Chairman Geithner that we need and I need--and I have a very important role here--to maintain clarity in communication about our attention to inflation, that we are not ignoring that side of the mandate. Finally, let me just say, as I said last night at the dinner with the presidents, that I think we are getting to the point where the Federal Reserve's tools, both its liquidity tools and its interest rate tools, are not by themselves sufficient to resolve our troubles. More help, more activity, from the Congress and the Administration to address housing issues, for example, would be desirable. We are certainly working on those issues here at the Board, and I will be talking to people in Washington about what might be done to try to address more fundamentally these issues of the housing market and the financial markets. So those are my comments. Why don't we turn now to Brian for an introduction to the policy round. " CHRG-111hhrg51591--99 Mr. Webel," Well, basically, I mean, it is convenient because the balance of trade accounting has two specific columns in it: One is for essentially insurance services; and one is for non-insurance financial services, i.e., primarily banking and securities. So I believe they release the data quarterly, or it may be annually. You know, when they release the new data, it is very easy to go to the Web site and say, okay, this is the amount that the trade deficit was in these services for the past year or the past quarter. And so you can look at it very clearly that it is fairly striking that in non-insurance financial services, we have consistently run a fairly substantial surplus. In insurance financial services, we have consistently run a fairly substantial deficit. And there isn't necessarily anything wrong with that in the sense that--you know, in the automobile industry, if you looked at imports and exports of SUVs versus small sports cars, the Germans and Italians probably import small sports cars--or we import them from Germany. We would export SUVs. So it is not unheard of to have the same industry with differentiation among product types, but it is still--I mean, it is still interesting to note that our banking system, our security system, seems to be very competitive on the world stage, and the insurance system isn't. " FOMC20080130meeting--74 72,MS. LIANG.," As discussed earlier, Treasury yields and stock prices are down sharply since the December FOMC meeting on news that indicated greater odds of a recession and large writedowns at financial institutions. As shown by the blue line in the top left panel of exhibit 6, the fall in stock prices pushed up the ratio of trend forward earnings to price. The difference between this ratio and the real Treasury perpetuity yield, shown by the shaded area and plotted to the right, is a rough measure of the equity premium. As you can see, this measure jumped in the past few months and is now at the high end of its range of the past twenty years. In the corporate bond market, the spread on high-yield corporates, the black line in the middle panel, widened sharply, and investment-grade spreads, the red and blue lines, also rose. Forward spreads (not shown) rose especially in the near-term, suggesting particular concern about credit risk in the next few years. In the forecast, we assume that the equity premium and bond spreads will recede some from their recent peaks as the risk of recession recedes and activity picks up, but they will remain on the wide side of their historical averages. As shown in the bottom left panel, our most recent indicators suggest that the OFHEO national purchase-only house-price index, the black line, fell 2� percent in the fourth quarter; we project further declines of about 3� percent in both 2008 and 2009. In some states with many subprime mortgages-- such as California, Arizona, Nevada, and Florida--house prices, the red line, began to fall earlier and have declined by more. Reports of spectacular writedowns from some financial firms may also have caused investors to assign greater odds of tighter financial conditions. As noted in the bottom right panel, financial firms took writedowns and loan-loss provisions of more than $80 billion in the fourth quarter. Most of the reported losses were from subprime mortgages and related CDO exposures, but many banks also increased loss provisions for other types of loans. In response, financial firms raised substantial outside capital and cut dividends and share repurchases. Still, the risk remains that writedowns and provisioning will grow larger if house prices or economic activity will slow more than currently anticipated or if financial guarantors are downgraded further. Moreover, many of the largest firms are still at risk of further unplanned asset expansion from previous commitments for leveraged loans and their continued inability to securitize non-agency mortgages. Consequently, these firms are likely to be cautious in managing asset growth. Your next exhibit focuses on business financial conditions. As shown by the black line in the top left panel, top-line operating earnings per share for S&P 500 firms for the fourth quarter are now estimated to be about 23 percent below their year-ago level, dragged down by losses at financial firms. For nonfinancial firms, the green line, earnings per share are estimated to be up 10 percent from a year ago. Analysts' estimates of Q1 earnings for nonfinancial firms were trimmed a bit last week but suggest continued growth. Robust profits since 2002 have put most businesses in strong financial shape. As shown in the right panel, loss rates on highyield corporate bonds, the black line, have been near zero for more than a year as very few bonds defaulted and recovery rates were high. However, we project that bond losses will rise gradually in the next two years as the nonfinancial profit share slips from its currently high level. In commercial real estate, the middle left panel, the net charge-off rate at banks, the black line, was low in the third quarter of last year despite a slight tilt up mostly from troubled loans related to residential land acquisition and construction. We project that this rate will rise fairly steeply, reflecting weakness in housing and expected softening in rents for commercial properties. A similar outlook may lie behind the tighter standards for business loans reported in the January Senior Loan Officer Opinion Survey. As shown by the orange line in the middle right panel, the net percentage of domestic banks reporting having tightened standards on commercial real estate loans in the past three months reached 80 percent, a notable increase from the October survey. In addition, one-third of domestic banks tightened lending standards on C&I loans in the past three months. Large majorities of the respondents that tightened standards pointed to a less favorable or more uncertain outlook or a reduced tolerance for risk. Despite wider spreads, borrowing rates for investment-grade firms are lower than before the December FOMC meeting. As shown by the red line in the lower left panel, yields on ten-year BBB-rated bonds, the red line, fell about 25 basis points, and rates on thirty-day A2/P2 nonfinancial commercial paper, the blue line, have plummeted about 200 basis points since just before year-end. In contrast, yields on ten-year high-yield bonds, the black line, are up and now are close to 10 percent. Net borrowing by nonfinancial businesses, shown in the right panel, is on track in January to stay near the pace of recent months. Net bond issuance, the green bars, has been sizable in recent weeks with most of that issuance by investment-grade firms. Unsecured commercial paper, the yellow bars, rebounded after substantial paydowns ahead of year-end. Your next exhibit focuses on the household sector. As shown in the top left panel, delinquency rates at commercial banks for credit cards, the blue line, and nonrevolving consumer loans, the black line, edged up in the third quarter, as did rates for auto loans at finance companies through November. Some of the recent rise in delinquency rates for credit cards is in states with the largest house-price declines, and could represent spillovers from weak housing markets. As shown to the right, delinquency rates on subprime adjustable-rate mortgages, the solid red line, continued to climb and topped 20 percent in November, and delinquency rates on fixed-rate subprime and on prime and near-prime mortgages also rose. Looking ahead, we expect delinquency rates on consumer loans to rise a bit from below-average levels as household resources are strained by higher unemployment and lower house prices. These developments have spurred lenders to tighten standards on consumer loans. As noted in the middle left panel, responses to the January Senior Loan Officer Opinion Survey indicate a further increase in the net percentage of banks tightening standards on credit cards and other consumer loans in the past three months. Banks also reported substantial net tightening of standards for subprime and prime mortgages, with the latter up considerably from the October survey. In addition, spreads on lower-rated tranches of consumer auto and credit card ABS jumped in January amid news that lenders were increasing loan-loss provisions. That said, interest rates on auto loans and credit cards, not shown, are not up, and most households still appear to have access to these forms of credit. As shown to the right, issuance of securities backed by these loans was robust through January. Securitization of nonconforming mortgages, the grey bars in the lower left panel, was weak in the fourth quarter of last year, and there has been little, if any, this month. But agency-backed securitization, the red bars, was quite strong in the fourth quarter and appears to be again in January. Moreover, as shown to the right, interest rates have fallen appreciably. Rates on conforming thirty-year fixed-rate mortgages, the blue line, and one-year ARMs, the red line, fell, and offer rates on prime fixed-rate jumbo mortgages, the black line, are also down. The six-month LIBOR, the rate to which most subprime ARMs reset, plunged in January, although, even at this level, the first payment reset will still be substantial for many households. The next exhibit presents our outlook for mortgage defaults. The top left panel shows cumulative default rates for subprime 2/28 ARMs by year of origination. A default here is defined as a loan termination that is not from a refinancing or sale. The default rates for mortgages originated in 2006 and 2007, the red and orange lines, respectively, have shot up, and for mortgages originated in 2006, about 18 percent will have defaulted by the loan age of eighteen months. This rate is higher at every comparable age than for mortgages made in 2005, the blue line, and the average rate for loans made in 2001 to 2004, shown by the black line, with the shaded area denoting the range across years. Softer house prices likely played an important role in defaults on 2006 and 2007 loans because borrowers had little home equity to tap when they lost their jobs or became ill, or they walked away when their mortgages turned upside-down. These mortgages have not yet faced their first interest rate reset. As shown to the right, we expect a sizable number of borrowers to reset to higher payments, about 375,000 each quarter this year, if these mortgages are not prepaid or rates are not reduced. While many borrowers still have time to refinance or sell before the first rate reset, lower house prices and tighter credit conditions are likely to damp this activity. As noted in the middle left panel, to project defaults on subprime ARMs, we use a loan-level model that jointly estimates prepayments and defaults. The model considers loan and borrower characteristics at origination, subsequent MSA- or state-level house prices and employment fluctuations, interest rates, and ""vintage"" effects. As shown to the right, with data for the first three quarters in hand, we estimate that defaults in 2007 about doubled from 2006 and predict that they will climb further in 2008 and stay elevated in 2009. These estimates imply that 40 percent of the current stock of subprime ARMs will default over the next two years. An important source of uncertainty around our projections is how borrowers will behave if falling house prices push their loan-to-value ratios above 100 percent. As shown in the first line of the bottom left panel, we estimate that 20 percent of subprime borrowers had a combined loan-to-value ratio of more than 100 percent in the third quarter of last year. If we assume that national house prices fall about 7 percent over the forecast period, as in the Greenbook, an estimated 44 percent of subprime mortgages would have combined LTVs above 100 percent. A similar calculation for prime and near-prime mortgages, shown in the second line, indicates that a not-inconsequential share, 15 percent, of these would also be upside-down by the end of 2009. While prime borrowers likely have other financial assets upon which to draw in the case of job loss or sickness, such high LTVs pose an upside risk to our baseline projection of defaults. Another source of uncertainty--this one on the positive side of the ledger--is how loan modifications can reduce defaults or loss of a home. We have limited information, but recent surveys indicate that loan workouts and modifications were modest through the third quarter of last year but likely accelerated in the fourth quarter. Servicers are strained working on the large number of loans that are delinquent before the first reset. One survey indicated that servicers assisted about 150,000 subprime borrowers in the third quarter, which would represent about 15 percent of those with past-due accounts, but were not addressing current accounts with an imminent reset. As highlighted in the top panel of your next exhibit, we summarize our projections for credit losses in the next two years for major categories of business and household debt. These projections rely on the paths for house prices, unemployment, interest rates, and other factors from the Greenbook baseline. We also present projections based on the Greenbook recession alternative with the additional assumption that national house prices fall 20 percent. In this alternative scenario, real GDP growth turns negative in 2008, and the unemployment rate rises above 6 percent in 2009. As shown in the first column of the bottom panel, if we use the loss rates over the past decade or two as a guide to approximate losses under average economic conditions, total losses, line 6, would be projected to be $440 billion over the next two years. Such losses could be considered what might be expected by lenders of risky debt in the normal conduct of business. But conditions over the next two years are not expected to be normal, even under the baseline scenario. As shown in the second column, losses under the Greenbook baseline are expected to be considerably higher than average and total $727 billion, given our outlook for only modest growth. These losses might not greatly exceed the amounts that investors already have come to expect given signs of slowing activity. The above-average losses are especially large for residential mortgages, line 1, including those for nonprime mortgages, line 2. In contrast, losses for consumer credit, line 3, and business debt, line 4, are only a touch higher than normal. In the alternative scenario, in which business and household conditions worsen further, losses are projected to rise even more, not only for mortgages but also for other debt. Losses of this dimension would place considerable strains on both households and financial institutions, creating the potential for more-serious negative feedback on aggregate demand and activity than is captured by our standard macroeconomic models. Nathan will continue our presentation. " FOMC20071211meeting--150 148,MR. EVANS.," Thank you, Mr. Chairman. I favor a ¼ point reduction in the fed funds rate today. As I noted earlier, assuming some ease in policy, my forecast is that the economy will experience subpar growth stretching into the middle of 2008 but then recover as we move into 2009 and that inflation will remain contained. Our forecast assumes that the disruptions in financial markets will generate more-restrictive credit conditions for consumers and businesses than we have seen to date, though not to the degree assumed in the Greenbook baseline. In light of my outlook, I think that policy should be somewhat accommodative; and given that I think the long-run neutral nominal funds rate is somewhere around 4½ to 4¾ percent, I support further easing. Given our expectations of coming financial restraint, there is a good chance that we will ultimately want to reduce the funds rate 50 basis points, but I prefer to go slower than that and move down only 25 basis points today. The slowing in consumption that we have recently seen reflects only a couple of months of data that followed quite strong growth during the summer, and much of that softening may reflect the transitory jump in gasoline prices. So I don’t think it is clear that we have seen a real change in the trajectory of consumption. I think the degree of financial spillover built into the Greenbook baseline is a plausible scenario, but we have not seen such spillover yet. The pessimistic view is a very forward-looking one, and I applaud forward-looking thinking. I am not quite there yet, but that is definitely a risk. I hesitate to say that we will know more next meeting because it is such an obvious thing to say, but I definitely agree with Governor Kohn that by the end of January we will at least have a better idea of how the TAF funding went and how much of the recent increase in liquidity demand and related disruptions are transitory end- of-year problems as opposed to more-fundamental problems that would impinge dramatically on credit conditions for nonfinancial borrowers. We will also know more about the actual strength of consumption and investment. Another concern I have about a 50 basis point move today is that the public might see it as an indication that we have read the incoming news more negatively than I at least think we should have, so I agree with Presidents Hoenig and Fisher on that. This would have negative implications for the already fragile state of consumer and market sentiment. But from here to a 4 percent fed funds rate, I think that the inflation risks are acceptable. Beyond that, I think it depends importantly on inflation developments and also developments in the economy. In terms of the statement, I prefer alternative B. I like the additional sentence that Brian was suggesting in section 4 for the balance of risks. But however that comes out, in reading section 2, when I was asking the question, it just seemed to me natural that after “incoming information suggests that economic growth is slowing” something like “somewhat more than previously expected” might be helpful, but nobody else has really mentioned that, and I am okay with that. Finally, on the political concerns, my memory is that we raised the funds rate during the 2000 and 2004 elections, so I am not really concerned about that, although people will wonder. Thank you, Mr. Chairman." FOMC20070321meeting--304 302,CHAIRMAN BERNANKE.," Certainly. Thank you very much. Let me thank the Committee for yet another very thoughtful and helpful discussion. I appreciate the time you’ve spent preparing for this. Thanks also to the staff. I thought the background materials were excellent. I’m not going to say much. I’m just going to make a couple of comments. If we do adopt an objective, it needs to be consistent with the dual mandate. That’s obvious and means a couple of things. One is that the long-run inflation rate would have to take into account, among other things, the zero bound. I think that is an issue. I would not be comfortable with a range that involves having the inflation rate, say, below 1 percent a significant amount of the time, stochastically speaking. So I think that’s a consideration. Second, because we have a dual mandate and because it’s an implication of optimal monetary policy, the horizon has to be quite flexible. Is that meaningless? I don’t think so. In particular, if we begin to use the projections more actively, the projections would give a good bit of guidance to the public about the time it takes to get back to the target range. In particular, we could also, through our communications, discuss how the adjustment period depends on initial conditions, the state of the economy, and so on. I’m flexible on the choice of index. I heard a lot of interesting discussion today. I am somewhat attracted to the headline CPI. I do think that people understand it more. It appears in labor contracts, for example, and in other wage discussions. It obviously appears in the TIPS and other places. So I think it’s worth considering. One possibility, choosing a headline CPI around 2 percent, would be reasonably consistent with a 1 to 2 percent core PCE in a sense because of the measurement difference. But that’s an open question. I think it remains to be discussed. We have a lot to digest here, and we’re going to be thinking very hard about all the comments we heard today. The subcommittee I know will try to come up with some. Don, I hope by tomorrow you’ll have a few—[Laughter] Again this has been very useful. I’d like to just make one comment on the projections, which again I think are potentially very valuable. This is about the assumption of appropriate monetary policy. The way that’s interpreted now is that each person chooses his or her own path for appropriate monetary policy, and I think that sometimes leads to somewhat confusing outcomes. If you have someone, for example, who is pessimistic about where inflation will actually go but who has a low inflation target and, therefore, has an appropriate monetary policy that’s much more aggressive than everyone else, he or she will report a good inflation outcome, and the press will report an optimistic Fed as far as where inflation is going to go. I would just like to put that out for consideration, since we’re going to do several dry runs. By the way, I don’t anticipate that we will be doing this live for the July Monetary Policy Report. This will take a while, so don’t worry about that. One alternative, which I believe I mentioned before, would be for us to make an unconditional forecast, by which I mean that we would essentially be saying, “Well, what do we think the Committee is going to do?” and conditional on that, what we would expect the economy to deliver. That, I think, would probably be easier for the public to understand than the way we do it now, with each person having his or her own conditioning policy assumptions. But I leave that for further discussion and for the staff also to think about. If there are no other comments, again, thank you. We will have lunch in the anteroom, and the next meeting will be May 9. We are adjourned. END OF MEETING" CHRG-111hhrg56847--239 Mr. Bernanke," Again, I don't know what would have happened in the absence. I think it did add to jobs. It did help growth. And clearly we needed that help because the economy was in a very weak condition a year ago. " FOMC20070131meeting--150 148,VICE CHAIRMAN GEITHNER.," Just in orders of magnitude—if we did another 25 or 50 basis points and there were some sort of associated changes in overall financial conditions so that that was reinforced, you’d get a core PCE inflation forecast that would go how far down? Would it go to 1.5?" CHRG-111hhrg63105--56 Mr. Chilton," Congressman, by and large they are a factor of the fundamentals, but I couldn't--and I am not an economist. Neil Cavuto tried to get me to say, well, how much is speculators and how much is price demand, and I wasn't going there. I am not an economist and it would be irresponsible. But to go to this thing about we need to document, we need to do this before we impose. The purpose of the Commodity Exchange Act says that we are to prevent and deter fraud, abuse, and manipulation. So all of a sudden we have been given, for people who don't want the regulation, this new hurdle to say, well, you have to prove beyond a shadow of a doubt that this equals that. These are very complicated markets, and it is not always easy to put things together like that. So to protect consumers, to ensure the folks in your districts are using these vehicles, like they want to, for adequate risk mitigation, that is why these limits are important to put in place thoughtfully. I get letters every day, Congressman. I have one right here from Dunkin' Donuts we received last night. They are concerned about speculation. Swift says they are thinking about getting out of the market in part because of speculation. Delta Airlines wrote the other day. These are real concerns about people, the hedgers who are in these markets that are concerned they can't use them. Look, nobody is talking about going crazy on this. We just want to--I just want to do what Congress intended and try to do it in a reasonable fashion; doesn't make anything crazy, just do what we are told. " FOMC20050202meeting--227 225,MS. DANKER.," I’ll read the directive and the risk assessment language from page 29 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 2½ percent.” “The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the February 1-2, 2005 135 of 177 measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”" CHRG-111shrg53085--214 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM DANIEL A. MICAQ.1. Corporate Credit Unions--Mr. Mica, last Friday the National Credit Union Administration placed two corporate credit unions, U.S. Central and Western Corporate, into conservatorship. Both of these corporate credit unions have suffered significant losses on their investments in mortgage-backed securities. What is your view on the reasons for the financial problems at these corporate credit unions?A.1. It is our understanding that the National Credit Union Administration Board was concerned about the level of estimated losses the two corporate credit unions could have on their mortgage backed securities. These legal investments, most of which were AAA rated, were attractive and performing well when made. However, due to the economy and problems in the mortgage market, the value of these securities has been affected by the market and by concerns about potential credit losses relating to the underlying mortgage loans.Q.2. Do you believe there was adequate oversight of the investment portfolios of corporate credit unions?A.2. The National Credit Union Administration Board had examination staff that operated in each of these corporate credit unions and both were subject to examinations and financial reporting requirements on their investments. We do believe it is appropriate to review the regulatory process as it relates to the corporate credit unions, particularly with an eye toward proper regulation of concentration limits and whether longer-term investments should be limited for corporate credit unions.Q.3. What measures should be taken to restructure corporate credit unions?A.3. CUNA is attaching the comment letter we filed April 6, 2009, with NCUA on our recommendations for restructuring the corporate credit union system. While we support restructuring the corporate system, our comments focused on furthering the interests of natural person credit unions. Many credit unions rely on corporate credit unions for core services such as settlement, payments, and liquidity. These services should be continued and facilitated. At the same time, appropriate capital, corporate governance, supervisory and regulatory requirements should be developed that will enhance economies of scale and permit appropriate innovations that will help meet the needs of natural person credit unions into the future. VIA E-MAIL--regcomments@ncua.gov April 6, 2009Ms. Mary F. Rupp,Secretary of the Board,National Credit Union Administration1775 Duke StreetAlexandria, Virginia 22314-3428RE: CUNA's Comments on Advanced Notice of Proposed Rulemaking for Part 704, Corporate Credit UnionsDear Ms. Rupp: On behalf of the Credit Union National Association, we are filing this letter with the National Credit Union Administration to address the future of the corporate credit union system, in response to NCUA's Advance Notice of Proposed Rulemaking (ANPR) on the corporate credit unions. By way of background, CUNA is the largest credit union advocacy organization in this country, representing approximately 90% of our Nation's 8,000 state and federal credit unions, which serve 92 million members. This letter was developed under the auspices of CUNA's Corporate Credit Union Task Force (CCUTF), which is chaired by Terry West, President and CEO of VyStar Credit Union in Jacksonville, FL. The other members of the Task Force are: Robert Allen, President and CEO of Teachers FCU in Farmingville, NY; Dale Dalbey, President and CEO of Mutual Savings Credit Union in Birmingham, AL; Tom Gaines, President and CEO of the Tennessee Credit Union League; Frank Michael, President and CEO of Allied Credit Union in Stockton, CA; David Rhamy, President and CEO of Silver State Schools CU in Las Vegas, NV; and Jane Watkins, President and CEO of Virginia Credit Union in Richmond, VA. Kris Mecham, CUNA Chairman and President and CEO of Deseret First FCU in Salt Lake City, UT; Tom Dorety, Immediate Past CUNA Chairman and President and CEO of Suncoast Schools FCU in Tampa, FL; and Harriet May, CUNA Vice Chairman and President and CEO of GECU in El Paso, TX, serve as ex officio members. While the restructuring of the corporate credit union system is very significant, most federally insured credit unions have been focused on, and are extremely concerned about, the costs they must bear in connection with the National Credit Union Share Insurance Fund's (NCUSIF) assistance for corporate credit unions. These include the write down and replenishment of their 1 percent NCUSIF deposit, their insurance premium costs, and the impairment of their capital in their corporate credit unions that many credit unions must reflect. This letter addresses both the immediate issues related to NCUA's recent actions on corporate credit unions and the longer-term restructuring questions, beginning with a summary of the issues and our responses.I. Summary of CUNA's ViewsA. Costs of NCUA's Assistance for Corporate CUs The costs associated with the NCUSIF's assistance to the corporate credit unions, along with the impairment of credit unions' capital in their corporate credit union, will have a deleterious impact on the credit union system if they must be absorbed in one year. CUNA and the Corporate Credit Union Task Force have urged NCUA since January 28th, when it announced the NCUA Corporate Credit Union Stabilization Plan, to provide a mechanism to allow credit unions to spread out their costs, as the Federal Deposit Insurance Corporation (FDIC) has done for banks. Most in the credit union system feel the Board should not have announced the Corporate Stabilization Plan in January without having developed a mechanism to spread out the costs to credit unions. CUNA will continue to do all we can to attain a better outcome for credit unions than the current situation, including through assistance from the U.S. Treasury. However, CUNA strongly commends the Board for its work on its new legislative proposal, which is addressed below, and we want to continue to work with NCUA and others to achieve amendments that will help mitigate the impact of the costs on credit unions. We particularly support NCUA's proposal to establish a Stabilization Fund that, if approved by Congress, could borrow from the Treasury to fund assistance to corporate credit unions, which will help spread out the costs to federally insured credit unions. NCUA's proposed amendment calls for $6 billion in borrowing authority for the new Stabilization Fund--a figure very close to NCUA's estimated $5.9 billion in insurance costs to fund the assistance to the corporate credit unions. Additional authority for NCUA to borrow up to $18 billion in emergencies, with approval from the Treasury and others, is also pending. CUNA agrees these changes are an improvement over the current $100 million in borrowing authority for the agency. However, we support seeking greater borrowing authority for the NCUSIF or the new Stabilization Fund, to give NCUA and credit unions even more flexibility in dealing with insurance costs, to the extent efforts to pursue higher borrowing authority do not jeopardize our ability to achieve legislation that will mitigate the impact of the costs on the credit union system. CUNA also supports statutory amendments that will give credit unions up to eight years to pay for insurance costs. In addition, we are advocating an amendment that will allow the Central Liquidity Facility to provide liquidity directly to the corporate credit unions, as another tool to assist NCUA and the credit union system. From the time NCUA announced it had contracted with PIMCO to analyze the securities held by corporate credit unions, CUNA has been urging NCUA to provide adequate information to credit unions from the report, particularly the assumptions and analyses regarding losses. Credit unions need the information so they can determine the reasonableness of the agency's cost estimates relating to the losses within the corporate credit unions and the resulting insurance assessments to credit unions. These assumptions have an additional negative impact on many credit unions because of the impairment of their capital in their corporate, which will not be addressed by the new legislation. Until now, credit unions have had no way to assess the agency's assumptions regarding these costs. On April 3, 2009, NCUA Board Chairman Michael Fryzel announced that key information from the PIMCO report will be provided to the members of the two corporate credit unions placed into conservatorship, WesCorp and U.S. Central, and the state regulators. A summary of significant information from the report will be provided to others. He also announced that the two corporate credit unions are each obtaining an independent, third-party assessment of the credit losses for their asset- backed securities. CUNA commends this NCUA Board action and wants to continue to work with NCUA to achieve transparency regarding the agency's corporate credit union actions to the fullest extent possible and appropriate. This includes providing sufficient information regarding the PIMCO report and other key information to the entire credit union system so that credit unions will be able to evaluate whether the agency's credit loss evaluations and the various agency decisions, which were based on those evaluations, are reasonable. The actual losses that credit unions will ultimately have to bear from the asset- and mortgage-backed securities in corporate credit union portfolios will depend in large part on those securities being held until they have been largely amortized. While NCUA has indicated it plans to hold the securities to maturity, we believe it is imperative that NCUA take additional steps to assure credit unions that, unless it can work with Treasury to obtain a favorable price well above the current market value for the securities before they mature, these securities will not be sold prior to almost complete amortization. A number of accounting issues have arisen since the announcement of the assistance to the corporate credit unions and the two corporate credit union conservatorships. The issues generally relate to when and to what extent natural person credit unions must report the impairments of their NCUSIF deposits and capital in their corporate credit unions. While credit unions have raised concerns about NCUA's accounting guidance in Accounting Bulletin (AB 09-2) CUNA appreciates the latest agency memorandum to examiners, which indicates credit unions will not be dealt with harshly if they do not report their NCUSIF deposit impairment on their March 31, 2009 statements. CUNA wants to continue working with NCUA to achieve as much clarity for credit unions on these issues as possible.B. Corporate CU Services Corporate credit unions should focus on core services of settlement, payment systems, and meeting the short-term investment and liquidity needs of their member credit unions. Long-term investments have created serious problems for the corporate credit union system that natural person credit unions are now having to pay for. Corporate credit unions should not be permitted to concentrate their assets in long-term, on-balance sheet investments because such activities have resulted in some corporate credit unions taking on more risk than they could reasonably manage or mitigate.C. Corporate CU Structure The current two-tier corporate system has outlived its utility and characteristics of the system that have facilitated undue risk taking, reduced credit unions' capital, and created inefficiencies must be eliminated. Requiring corporate credit unions to focus on payments, settlement and short-term investments and liquidity will reduce the number of corporate credit unions. CUNA is not advancing a specific number of corporate credit unions, and it is not recommending that NCUA determine the appropriate number. However, the number of corporate credit unions should be small enough to reflect operational efficiencies that benefit natural person credit union members. Further, a single interface between the corporate credit union system and key payment and settlement entities could be extremely beneficial as it could combine and strengthen credit unions' ability to influence governmental and private sector decisions in these areas that impact credit unions' operations. At the same time, having more than one corporate credit union to provide one or more of the core services for natural person credit unions could prove to be beneficial. In any event, the number of corporate credit unions should be sufficient to promote innovation among the remaining corporate credit unions and avoid a potential single point of failure that could arise if only one corporate credit union survives.D. Capital of Corporate CUs Corporate credit unions' Tier 1 capital requirement should be at least 4% and could be as high as 6%. Risk-based capital should also be required. Natural person credit unions that use corporate credit unions should be required to maintain contributed capital in their corporate.E. Corporate Governance Corporate credit unions should be permitted to have outside, nonmember directors who can contribute diverse experiences to a corporate credit union's board. A corporate should be permitted to have up to 20 percent of its board comprised of nonmembers and also be permitted to pay a nonmember director a reasonable director's fee. Such fees should be comparable to those paid by federally insured depository institutions of similar asset size, so long as the amount of this fee and any other director compensation is fully disclosed to the corporate credit union's members.F. Fields of Membership CUNA supports allowing corporate credit unions to have national fields of membership.II. Discussion of CUNA's Recommendations and Key PointsA. NCUA's Corporate Credit Union Stabilization Program Few, if any, issues confronting the credit union system are of greater significance than the National Credit Union Administration's handling of the financial predicament that has confronted the corporate credit union system. That is because the economic, political, and member/public relations issues associated with NCUA's decision to place U.S. Central Corporate Federal Credit Union and Western Corporate Federal Credit Union into conservatorship, as well as the NCUSIF assistance to corporate credit unions announced in January which combined are now estimated to cost federally insured credit unions $5.9 billion, will have serious ramifications now and well into the future--particularly if credit unions have to write down these costs all in one year. While issues relating to the funding of the assistance to the corporate credit unions are not part of the ANPR, our members have urged us to address these matters in the context of this comment letter. Our members feel strongly that they should be able to spread out as much of their insurance costs as possible over time, particularly in light of the fact that the FDIC determined that a special insurance premium amounting to 20 basis points of insured deposits, on top of the regular 12 to 16 basis point premium, was too much for the banks to fund in one year. Following complaints from the banks, the FDIC reduced this year's special assessment to 10 basis points, for a total of 22 to 26 basis points--far less than the insurance costs credit unions are expected to pay. Since January 28, 2009, when NCUA announced the corporate assistance, CUNA and its Corporate Credit Union Task Force have been urging NCUA to adopt alternative approaches for funding the assistance that will help spread out the program's insurance costs to credit unions. \1\ As we have discussed with the agency, while some options would take time to implement, in our view NCUA has the legal authority to spread out all premium costs that restore the NCUSIF equity to over 1 percent of insured shares. \2\ NCUA does not need approval from Congress or Treasury to take this action.--------------------------------------------------------------------------- \1\ In addition to spreading out the insurance costs, CUNA has urged NCUA to pursue other means to mitigate credit unions' costs associated with the Corporate Stabilization Program, including funds from the Treasury's TARP, amendments to the FCU Act to allow the CLF to provide loans and capital to corporate credit unions, and options consistent with accounting rules that allow the agency to deviate from GAAP in recognizing its own costs to the NCUSIF. \2\ The 1 percent deposit is required to be replenished in the year the NCUSIF incurs an impairment that would reduce the Fund balance to below 1 percent, under the Federal Credit Union Act. However, for the premium costs which fund the .30 percent balance in the Fund, NCUA has authority under the FCUA to spread those costs out over time. 12 U.S.C. 1782(c)(1)(A), (c)(2).--------------------------------------------------------------------------- We do applaud NCUA's efforts to develop legislation that will help spread out all the insurance costs for credit unions, and we want to work with the agency as well as the National Association of State Credit Union Supervisors, the National Association of Federal Credit Unions, and the National Federation of Community Development Credit Unions to achieve its passage as quickly as possible. In particular, CUNA supports: The new proposal developed by NCUA to establish a Stabilization Fund that could borrow from the U.S. Treasury to fund assistance to corporate credit unions; and Legislation that will give credit unions up to seven or eight years to pay for insurance costs and increase the authority of the NCUSIF to borrow from the Treasury in exigent circumstances. NCUA's new proposal calls for $6 billion in borrowing authority for the Stabilization Fund, absent exigent circumstances. This level is very close to the $5.9 billion estimate NCUA has indicated the insurance costs to credit unions will e as a result of the corporate credit union assistance. Pending legislation will allow NCUA to borrow up to another $12 billion from Treasury in emergencies, but only with the approval of Treasury and others. These proposed limits are improvement over the current $100 million borrowing authority, and we appreciate efforts to expand NCUA's borrowing authority. However, we hope to partner with NCUA to pursue even higher borrowing authority for the NCUSIF or the new Stabilization Fund, as long as such efforts will not place the legislation to mitigate the impact of the costs on the credit union system at risk. We also support an amendment to allow the Central Liquidity Facility to provide short-term loans directly to corporate credit unions, and we would welcome NCUA's support to include this amendment in the Stabilization Fund legislation. While CUNA commends the Board for its work on this proposal, our members feel the Board should not have announced the assistance for the corporate credit unions without providing an acceptable mechanism to spread out the costs credit unions will bear--particularly given the impact of these costs on credit unions in some areas, which have already been weakened by the current economic crisis. The decisions NCUA has made this year regarding the corporate credit union system are among the most monumental the agency has ever made and will continue to impact the entire system for years to come. Since NCUA announced it had contracted with PIMCO to analyze the securities held by corporate credit unions, CUNA has been urging NCUA to provide adequate information to credit unions so they could determine the reasonableness of the agency's cost estimates relating to losses within the corporate credit unions and the resulting insurance assessments to credit unions. These assumptions will have an additional negative impact on many credit unions because of the impairment of their capital in their corporate credit unions, which will not be addressed by the new legislation. Until now, credit unions have had no way to assess the validity of the agency's assumptions regarding these costs. On April 3, 2009, NCUA Board Chairman Michael Fryzel announced that key information from the PIMCO report will be provided to the members of the two corporate credit unions placed into conservatorship, WesCorp and U.S. Central, as well as to the state regulators. A summary of significant information from the report will be provided to others. He also announced that the two corporate credit unions are each obtaining an independent, third-party assessment of the credit losses for their asset-backed securities. CUNA commends this NCUA Board response and wants to continue to work with NCUA to achieve transparency regarding the agency's corporate credit union actions to the fullest extent possible and appropriate. We are hopeful that sufficient information regarding the PIMCO report will be provided to the entire credit union system so that credit unions will be able to evaluate whether the agency's credit loss evaluations and the various agency decisions, which were based on those evaluations, are reasonable. The estimate of the costs to the share insurance fund for the Corporate Stabilization Program ($5.9 billion as of this writing) is indeed just that, an estimate. The ultimate losses derived from the portfolio of securities held by the corporate credit unions depends on two factors: the actual credit losses on the securities (determined by various and complicated future economic events), and the extent to which the securities might be sold prior to full amortization, resulting in market losses that could exceed the eventual credit losses. Credit unions understand that they will eventually be responsible through the share insurance fund for the actual credit losses in the portfolio, and that the extent of these losses is currently unknowable. They are, however, very concerned that they might be forced to pay additional market losses resulting from premature sales of the securities. Credit unions understand that the agency would not be in a position to sell the securities so long as the market losses exceed the available reserves (including the $5.9 billion added to available funds). Yet they are anxious that once the Fund is ``in the money,'' counting existing capital and the additional $5.9 billion, the pressure on the agency to sell the remaining securities and lock out any future increases in losses could become acute. NCUA has released a statement and Board members have indicated the agency's intent to hold the securities until maturity, which is positive. However, credit unions continue to seek assurances that the agency will be able to withstand pressure and hold the securities until they are largely amortized or essentially back to par, unless it is able to work with the Treasury to sell corporate credit unions' assets before they mature at favorable prices well above their current market values. Finally, a number of accounting issues have arisen since the announcement of the assistance to the corporate credit unions and the two corporate credit union conservatorships. These relate to when and to what extent natural person credit unions must report the impairments of their NCUSIF deposit and capital in their corporate credit unions. These are not easy issues and questions remain concerning appropriate accounting treatments. The latest agency memorandum to examiners indicates credit unions will not be dealt with harshly if they do not report their NCUSIF deposit impairment on their March 31, 2009 statements. CUNA appreciates this development and wants to continue working with NCUA to achieve as much clarity for credit unions on these accounting issues as possible in a timely fashion.B. CUNA's Corporate Credit Union Task Force Prior to NCUA's issuance of the ANPR, in recognition of the serious issues facing corporate credit unions, CUNA formed the Corporate Credit Union Task Force (CCUTF) earlier this year. \3\ The CCUTF has met a number of times to consider the issues outlined in the ANPR. The role of the Task Force has been to review the current corporate credit union network, assess the nature and scope of the problems within the network, and to develop forward thinking, feasible recommendations to address those problems responsibly.--------------------------------------------------------------------------- \3\ Members of the Task Force are Terry West, chair, Robert Allen, Dale Dalbey, Tom Gaines, Frank Michael, David Rhamy, and Jane Watkins; Kris Mecham, Tom Dorety, and Harriet May serve as ex officio members.--------------------------------------------------------------------------- A key objective for the Task Force in crafting its recommendations for reform of the corporate system has been to ensure the interests and needs of natural person credit unions for payment and settlement services as well as short-term liquidity are met. The Task Force also sought to develop recommendations that would mitigate the risks associated with corporate credit union operations. This letter reflects their views, as well as those of numerous credit unions and Leagues that responded to this request for comments. It has also been reviewed by CUNA's Governmental Affairs Committee as well as our Board of Directors, and it represents CUNA's official positions. CUNA's GAC and Board reflect a broad cross-section of American's credit unions by size, region, and charter types.C. The Future Structure of the Corporate System CUNA is aware that the first task the Board must deal with regarding corporate credit unions is stabilizing the system in the near-term. Once that has been accomplished, a transition to a revised system will be necessary. In our comments that follow, we deal only with what the optimal system should be, not with the mechanism of how to transform the current system to its future form. Corporate credit unions have historically fulfilled an important role by providing natural person credit unions with settlement and payment services. In addition, corporate credit unions have played a major role in meeting both the short- and long-term investment needs of credit unions, and in providing short- and medium-term loans to credit unions. As a result of the current economic crisis, many corporate credit unions have experienced a dramatic reduction in the market value of their investments. These reductions have been exacerbated by the virtual shutdown of the market for mortgage-backed securities and other investments. This series of events has severely undermined the stability of the corporate credit union system. CUNA believes that the future structure of the corporate credit union system must be very different from the one that has evolved over the past three decades, if it is going to be well positioned to meet the needs of member credit unions while successfully managing risk. Changes must be made to the number of tiers within the system, the number of corporate credit unions, the services they provide, their capitalization, and governance. Ultimately, the driving factor must be the set of services that it is essential for credit unions to receive from a corporate system. Once those services are established, the remaining issues concerning the future of the corporate system can be determined.D. Services Provided by the Restructured Corporate System Services currently provided by corporate credit unions can be divided into the following mutually exclusive categories: Payment processing, such as checks, ACH, Wire Transfers, ATM and debit, etc. Payment processing involves transferring information about financial transactions (payments) so that the financial institutions of both the payor and payee know when to debit or credit whose account by how much. In addition to corporate credit unions, a number of other vendors provide various types of payment processing to credit unions. Settlement. This function involves transferring money among financial institutions to settle out the net effect of inflows and outflows resulting from payments and other credit union transactions. Settlement requires a financial institution charter, and maintaining accounts at a Federal Reserve Bank and other financial institutions to execute and manage the transfer of funds. Short-term investments. This function involves investments credit unions make with overnight funds, and other short-term investments. The limit for short-term investments could be as short as three months, but no longer than one year. Short-term liquidity. This function involves providing short-term lending to credit unions. This could be for as short as overnight to facilitate a credit union's settlement accounts, to slightly longer to allow credit unions to adjust to monthly or seasonal liquidity flows. Long-term investing. This involves portfolio investing for credit unions with longer maturities than defined as short-term investing. Long-term liquidity. This involves longer term lending to credit unions. Credit unions typically undertake such borrowing not to adjust to net loan and savings inflows, but instead for asset/liability management purposes such as holding longer term loans. Among these services, the core function that credit unions require from a corporate credit union system is settlement. Settlement provides the point of contact of the credit union movement with the rest of the financial system, and we believe that credit unions would be placed at a significant disadvantage if they had to individually arrange for settlement services with correspondent or Federal Reserve banks. Settlement is a function that can be performed efficiently at scale by a very few endpoints for the entire credit union system. Whatever institution provides settlement services must also be able to provide short-term investing and liquidity. A credit union's settlement account is its overnight, interest-earning account. Access to overnight or very short-term loans is also necessary for settlement. These then comprise the core functions that the future corporate system must be designed to offer: settlement, short-term investments, and short-term liquidity. Payment processing is often linked to settlement and short-term liquidity and investment, and there can be efficiencies in a corporate credit union offering various types of payment processing. CUNA supports payment processing as a permissible activity for corporate credit unions because it is often so closely related to settlement.E. Long-Term Investments and Concentrations in Such Investments for Corporate Credit Unions Should Be Curtailed and Managed Many believe that, in the future, corporate credit unions should not be engaged in longer-term investing (on the corporate credit union's balance sheet). Long-term investments and liquidity are not crucial to the settlement function, and longer-term investing has been the source of most of the serious problems in the corporate system, such as the failure of CapCorp and the current problem of unrealized losses on illiquid securities. Corporate credit unions could in theory successfully and safely engage in providing term investment services on their own balance sheets, but permissible investment activities would need to be more restrictive than current regulations, and corporate credit unions would have to be required to hold capital levels far in excess of what credit unions would likely be willing to provide. A number of credit unions believe there is not enough capital in the credit union movement to fund long-term investments on the balance sheets of both natural person and corporate credit unions. Another consideration in removing long-term investing from corporate credit unions is the fact that it is feasible for credit unions to meet their long-term investing needs through means already available outside corporate credit union balance sheets: securities purchases, mutual funds, investment advisory services, and deposits in other financial institutions. Corporate credit unions have traditionally held relatively broad authority to engage in long-term (greater than one year) investing. Absent such authority, corporate credit unions likely would not have been able to obtain the favorable yields they have been able to garner and pass on to their member credit unions. Obtaining such yields, however, has not been without substantial risk for the corporate credit union system. Furthermore, as the system is currently structured, losses stemming from these long-term investments can have a direct, detrimental affect on natural person credit unions and on other aspects of the corporate credit unions' operations, including payment, settlement, and liquidity services. Part 12 C.F.R. 704.5(c), Investments, of NCUA's Rules and Regulations, describes corporate credit unions' current basic investment activities, which CUNA supports for corporate credit unions going forward. These include investments in: Securities, deposits, and obligations set fort in Sections 107(7), 107(8), and 107(15) of the Federal Credit Union Act; Deposits in, the sale of federal funds to, and debt obligations of corporate credit unions, Section 107(8) institutions, and state banks, trust companies, and certain mutual savings banks; Corporate CUSOs; Marketable debt obligations of certain corporations; and Domestically issued asset-backed securities. Additionally, Appendix B to Part 704, Expanded Authorities and Requirements, details the riskier investments that qualifying corporate credit unions can purchase, such as long-term investments rated no lower than BBB. NCUA attempts, in Appendix B, to mitigate the risk involved with these investments by mandating that participating corporate credit unions fulfill ``additional management, infrastructure, and asset and liability requirements.'' Corporate credit unions seeking to purchase long-term, Appendix B investments must first be granted prior approval--which can subsequently be removed at any time--by NCUA. Even with the above-mentioned safeguards, the risk to the entire credit union system associated with certain short-term investments, such as asset-backed securities, and long-term investments in Appendix B may be too great. The possible long-term investments enumerated under the appendix include those that have resulted in much of the corporate credit unions' unrealized losses and other-than-temporarily impaired assets. However, while removing the authority to invest in riskier long-term investments will reduce the risk to the entire credit union system, such limitations will also have the consequence of reducing the earning potential of natural person credit unions. Many of these credit unions have already been heavily invested in their corporate credit unions. In light of these concerns about investments and concentrations of assets in a limited number of investment vehicles, CUNA encourages NCUA to consider the extent to which longer-term, riskier investments for corporate credit unions should be dramatically curtailed and whether alternative means for natural person credit unions to invest in some additional investments should be pursued. To be clear, CUNA encourages NCUA to consider supporting natural person, not corporate, credit unions to have the option to purchase alternative investments vehicles, such as those authorized under the proposed Credit Union Regulatory Improvement Act (CURIA). Section 301, Investments in Securities by FCUs, of CURIA, for example, would authorize the Board to permit natural person credit unions to purchase certain investment securities as the Board sees appropriate. Allowing natural person credit unions to make such investments through providers outside the credit union system would have the effect of moving some of the risk away from the National Credit Union Share Insurance Fund (NCUSIF). Any investment losses suffered by natural person credit unions would affect the NCUSIF only if they substantially reduce the credit unions' net worth, and even then might be covered by FDIC insurance if the investment provider were a federally insured bank.F. The Number of Corporate Credit Unions and Their Tiers Once the primary function of corporate credit unions has been determined to be the provision of settlement services and closely related activities, the issue of the appropriate number of corporate credit unions can be addressed. Processing payments and handing settlement are scale businesses, so the number of corporate credit unions can be sharply reduced to a very small number. With only a few, large corporate credit unions serving natural person credit unions, there would no longer be the need for a two-tiered structure. Achieving economies of scale and enhancing the ability of the credit union system to influence and interface with the settlement process supports a good case for having only one corporate credit union. Under this approach, the remaining corporate credit union would serve as the settlement gateway from the entire credit union movement to the rest of the financial system on settlement and related issues. The principles and recommendations outlined in this letter would not preclude that outcome. However, economies of scale are not the only considerations regarding the number of corporate credit unions into the future. Beneficial effects on pricing and innovation are also needed, which may be harder to attain without some direct credit union-market competition. In any event, CUNA does not support having NCUA determine the appropriate number of corporate credit unions. Rather, we believe that as a result of capital requirements and limits on services and investments, member credit union owners should contemplate no more than a very limited number of corporate credit unions--small enough to take advantage of economies of scale, but large enough to foster innovation and competition.G. Corporate Credit Union Capital CUNA believes that a corporate credit union's minimum Tier 1 capital ratio should be at least 4 percent and possibly higher, up to 6 percent over a reasonable period of time. If NCUA chooses to institute risk-based capital requirements for corporate credit unions, such risk-based capital should be comparable to those applicable to similarly situated FDIC-insured depository institutions. CUNA believes that market factors, such as corporate credit unions' payments system counterparties' concerns about counterparty risk, will generally encourage corporate credit unions to maintain higher net worth ratios of up to 6 percent. CUNA believes, however, that risk-based capital requirements are likely unnecessary for corporate credit unions if NCUA adopts CUNA's recommendations for limitations on corporate credit unions' business and investment activities, as outlined above. CUNA believes that if NCUA has concerns regarding the amount of capital necessary to cover corporate credit unions' payment and settlement risks, it should consider requiring a payment and settlement risk reserve that would be deducted from Tier 1 capital but included in Tier 2 capital to some degree, as discussed below under ``4.'' 1. Components of Corporate Credit Union Capital and Capital Ratios. CUNA believes that a corporate credit union's regulatory capital should consist of Tier 1 capital-reserves and undivided earnings (RUDE) as well as paid-in capital (PIC)-and Tier 2 capital. Corporate credit union Tier 2 capital should include member capital shares (MCS) as well as subordinated term debt and general reserves such as the ``Reserve for Payment and Settlement Risk'' discussed below. CUNA also believes that Tier 2 capital for corporate credit unions could include subordinated term debt because U.S. low-income credit unions count subordinated debt--in the form of a ``secondary capital account''--as regulatory capital, because Canadian credit unions count subordinated debt as regulatory capital, and because U.S. federal banking regulators and the Basel Committee on Banking Supervision also consider subordinated debt to be Tier 2 capital. \4\--------------------------------------------------------------------------- \4\ See, e.g., 12 C.F.R. Appendix A to part 325.--------------------------------------------------------------------------- 2. Require PIC Investments for Access to Corporate Services and Lengthen MCS. CUNA believes that natural-person credit unions should make meaningful PIC investments in a corporate in order to use that corporate credit union's services, that the callable period of member capital shares (MCS) should be extended to five years from three years, and that corporate credit unions should be permitted to write down called MCS over five years rather than two. In general, a natural person credit union's required PIC investment in a corporate credit union should be calculated based on the investing credit union's asset size, and its required MCS balance should be based upon its usage of the corporate credit union's services. Requiring natural person credit unions to contribute perpetual or 20-year-callable PIC to their corporate and extending the callablility and write-down periods for MCS will strengthen the corporate credit unions' capital positions. In addition, required PIC subscriptions by a corporate credit union's natural person credit unions members would give all users of a corporate credit union's services an increased incentive to monitor their corporate credit union's management and business activities. CUNA also believes that NCUA should consider making natural person credit unions' PIC investments transferable from one corporate to another, so long as the PIC of state-chartered corporate credit unions would not be considered ``capital stock'' within the meaning of 26 U.S.C. 501(c)(14)(A). CUNA believes that transferable PIC would not likely qualify as ``capital stock'' so long as it is clearly designated as a form of deposit. 3. Risk-Based Capital. If NCUA restricts corporate credit union business and investment in the manner suggested by CUNA, above, risk-based capital requirements for the corporate credit unions would likely not be necessary. However, if such investments are not restricted, then risk-based capital for corporate credit unions engaging in those activities is essential. If the Basel II risk-based capital rules developed by the Federal Reserve Board, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the FDIC applied to corporate credit unions, \5\ a corporate credit union that is invested solely in U.S. Treasury securities and other highly-rated fixed-income investments \6\ would have an 8 percent risk-based capital ratio requirement that would generally be lower than the amount of capital required by a 4 percent net worth ratio.--------------------------------------------------------------------------- \5\ See, e.g., Risk-Based Capital Guidelines; Capital Adequacy Guidelines: Standardized Framework, 73 Fed. Reg. 43982 (proposed July 29, 2008). FDIC-insured depository institutions are subject to a 3 percent absolute leverage ratio on Tier 1 capital and a risk-based capital ratio of 8 percent. See 12 C.F.R. 325.3; see also, e.g., 12 C.F.R. 3.6, Appendix A to 12 C.F.R. pt. 3 (national banks). \6\ I.e., generally AAA to AA-rated investments. These investments are typically assigned a risk-weighting of 20 percent, meaning that their value for risk-based capital calculation purposes is discounted to 20 percent of face value. See, e.g., Risk-Based Capital Guidelines; Capital Adequacy Guidelines: Standardized Framework, 73 Fed. Reg. 43982, 43991-98 (proposed July 29, 2008).--------------------------------------------------------------------------- Stated another way, risk-based capital requirements for corporate credit unions would generally be irrelevant-if corporate credit unions were subject to a minimum 4 percent net worth ratio and a minimum 8 percent risk-based capital ratio--until a corporate made significant investments in assets in the Basel II 50 percent risk category or the 100 percent or 150 percent risk-weight categories. Most potential corporate credit union investments would be placed in the 50 percent (or a higher) risk-weight category if they are rated below AA-. 4. Reserves for Payment and Settlement Risk. CUNA believes that corporate credit unions should hold sufficient capital to be insulated from operational risk arising from payment and settlement activities, possibly including a capital charge deducted from Tier 1 capital to establish appropriate reserves for payment and settlement risk. Under the Basel II standardized approach to controlling for payment and settlement operational risk, a corporate credit union's payments and settlement risk capital charge would be 18 percent of the three-year average of the corporate credit union's annual gross income from payment and settlement activities. CUNA believes that this reserve for payment and settlement risk should be deducted from Tier 1 capital but should be included in Tier 2 capital (possibly subject to a percentage of assets limitation, such as 1% of assets) because, under Basel II rules, this reserve would qualify as Tier 2 capital. This reserve qualifies under Basel II as Tier 2 capital because it is a general reserve that does not reflect a known loss or deterioration in a particular asset, and would be available to meet unidentified losses that may subsequently arise.H. Corporate Credit Union Governance CUNA believes that the boards of directors of corporate credit unions should generally consist of representatives of their member natural person credit unions, but that a corporate credit union should have the option of having up to 20 percent of its board consist of nonmember directors if its members so choose. CUNA wishes to note that most current corporate credit union directors are ``outside directors'' or ``independent directors'' within the common definitions of those terms, since they are not officers of the corporate credit union and, as individuals, have no direct financial interest in the corporate. \7\ These directors are typically representatives of the corporate credit unions' member natural person credit unions, none of which are individually able to exert control over a corporate because credit unions' one-member-one-vote voting structure prevents the concentration of voting power in the hands of a few. CUNA believes, therefore, that comparisons between the governance of corporate credit unions and that of for-profit, stock corporations with significant numbers of ``inside directors''--i.e., those who are also officers of the corporation and/or who represent the interests of controlling stockholders--are inapt.--------------------------------------------------------------------------- \7\ E.g., ``Outside Director,'' John Downes and Jordan Elliot Goodman, Dictionary of Finance and Investment Terms (Barron's, 7th ed. 2006) (``[A] member of a company's board of directors who is not an employee of the company.''); id. at ``Independent Director'' (``Independent Director: same as Outside Director''); Black's Law Dictionary 473 (7th ed., 1999) (``A nonemployee director with little or no direct interest in the corporation.'').--------------------------------------------------------------------------- Outside directors ``are considered important because they are presumed to bring unbiased opinions to major corporate decisions and also can contribute diverse experience to the decision-making process.'' \8\ CUNA believes that the outside directors representing the interests of corporate credit unions' member natural person credit unions currently serving on corporate credit unions' boards already bring unbiased opinions to major corporate decisions. CUNA does not believe that corporate credit unions should be required to have outside, nonmember directors because most current corporate directors already qualify as ``outside directors'' and because nonmembers may have interests that do not align with those of the corporate, or with the interests of credit unions generally.--------------------------------------------------------------------------- \8\ ``Outside Director'', Dictionary of Finance and Investment Terms.--------------------------------------------------------------------------- CUNA believes, however, that corporate credit unions should be permitted the option to have nonmember directors who can contribute diverse experience to a corporate credit union's board, if the corporate credit union's member natural person credit unions so choose. A corporate should be permitted to have up to 20 percent of its board be composed of non-members and also be permitted to offer a non-member director a reasonable director's fee comparable to that paid by federally insured depository institutions of similar asset size, so long as the amount of this fee and any other director compensation is disclosed to the corporate credit union's members. The NCUA Board has authority under section 120(a) of the Federal Credit Union Act to authorize a corporate to have nonmember outside directors and to pay those nonmember directors a reasonable fee.I. National Fields of Membership CUNA believes that the small number of corporate credit unions that operate in the future should continue to have national fields of membership. Without overlapping fields of membership, there would be no competition among corporate credit unions, and therefore, no need to have more than one. CUNA understands that competition among corporate credit unions may have in the past contributed to thinly capitalized institutions, operating on very low margins, taking significant investment risks. However, with sufficient capital requirements and with investments restricted to only those necessary to perform short-term investing and liquidity for credit unions, CUNA believes that competition among corporate credit unions would provide for better service to credit unions in a context of full safety and soundness.III. Conclusion Thank you for the opportunity to comment on the ANPR regarding the structure and operations of corporate credit unions. The issues raised in the ANPR are critical for all credit unions, and changes to the current corporate credit union structure, as outlined above, are imperative to ensure the continued vitality of both corporate and natural person credit unions. The entire credit union system is now in the process of absorbing the recent losses associated with corporate credit union investments. Although these losses will never be fully recovered, we strongly believe that adopting the principles and recommendations outlined in this letter will demonstrate the resiliency of the credit union system while helping to help ensure the unfortunate events involving the corporate credit unions are never, ever repeated. As stated above, CUNA supports NCUA's efforts to help spread out credit unions' costs associated with the Corporate Credit Union Stabilization Plan, including the proposed legislation, and to address related issues. We hope NCUA will work with us to: Seek statutory authority for the CLF to provide liquidity directly to corporate credit unions; Achieve higher statutory borrower authority for the agency beyond current proposals, to the extent such an effort does not jeopardize the success of any other aspect of the legislations; Reassure credit unions it plans to hold asset-backed securities of the two conserved corporate credit unions until maturity; and Help clarify remaining accounting issues concerning the reporting of impaired capital in corporate credit unions and the write-down of the NCUSIF deposit. We also welcome NCUA's announcement that a separate review of the securities of U.S. Central and WesCorp has been undertaken, and that the agency will make critical information from the PIMCO available to the credit union system. We look forward to reviewing the data. We also recognize that the restructuring of the corporate credit union system will continue to be a difficult process. CUNA and the CCUTF will be available throughout this process to meet with NCUA to work through these very complex issues. Meanwhile, please do not hesitate to contact us at (202) 638-5777 if you have any questions about our comments. Sincerely, Daniel A. Mica, President and CEO Terry West, President/CEO of VyStar CU, and CUNA Corporate Credit Union Task Force Chairman" CHRG-111shrg52619--200 RESPONSE TO WRITTEN QUESTIONS OF SENATOR HUTCHISON FROM DANIEL K. TARULLOQ.1. Will each of you commit to do everything within your power to prevent performing loans from being called by lenders? Please outline the actions you plan to take.A.1. The Federal Reserve's survey of senior loan officers at banks has indicated that banks have been tightening standards for both new commercial and industrial loans and new consumer loans since the beginning of 2008, although the net percentage of banks that have tightened standards in both categories has diminished a bit in recent months. We also are aware of reports that some banking organizations have declined to renew or extend new credit to borrowers that had performed on previously provided credit, or have exercised their rights to lower the amount of credit available to performing customers under existing lines of credit, such as home equity lines of credit. There is a variety of factors that potentially could influence a banking organization's decision to not renew or extend credit to a currently performing borrower, or reduce the amount of credit available to such a borrower. Many of these factors may be unique to the individual transaction, customer or banking organization involved. However, other more general factors also may be involved. For example, due to the ongoing turmoil in the financial markets, many credit and securitization markets have experienced substantial disruptions in the past year and a half, which have limited the ability of banking organizations to find outlets for their loans and obtain the financing to support new lending activities. In addition, losses on mortgage-related and other assets reduced the capital position of many banking organizations, which also weakened their ability to make or renew loans. The Federal Reserve, working in conjunction with the Treasury Department, has taken a number of important steps to help restore the flow of credit to households and businesses. For example, the Term Asset-Backed Securities Leading Facility (TALF), which began operations in March 2009, is designed to restart the securitization markets for several types of consumer and commercial credit. In addition, the recently completed Supervisory Capital Assessment Program was designed to ensure that the largest banking organizations have the capital necessary to fulfill their critical credit intermediation functions even in seriously adverse economic conditions. Besides these actions, we continue to actively work with banking organizations to encourage them to continue lending prudently to creditworthy borrowers and work constructively with troubled customers in a manner consistent with safety and soundness. I note that, in some instances, it may be appropriate from a safety and soundness perspective for a banking organization to review the creditworthiness of an existing borrower, even if the borrower is current on an existing loan from the institution. For example, the collateral supporting repayment of the loan may have declined in value. However, we are very cognizant of the need to ensure that banking organizations do not make credit decisions that are not supported by a fair and sound analysis of creditworthiness, particularly in the current economic environment. Striking the right balance between credit availability and safety and soundness is difficult, but vitally important. The Federal Reserve has long-standing policies and procedures in place to promote sound risk identification and management practices at regulated institutions that also support bank lending, the credit intermediation process, and working with borrowers. For example, guidance issued as long ago as 1991, during the commercial real estate crisis that began in the late 1980s, specifically instructs examiners to ensure that regulatory policies and actions do not inadvertently curtail the availability of credit to sound borrowers. \1\ The 1991 guidance also states that examiners are to ``ensure that supervisory personnel are reviewing loans in a consistent, prudent, and balanced fashion and to ensure that all interested parties are aware of the guidance.''--------------------------------------------------------------------------- \1\ ``Interagency Policy Statement on the Review and Classification of Commercial Real Estate Loans,'' (November 1991).--------------------------------------------------------------------------- This emphasis on achieving an appropriate balance between credit availability and safety and soundness continues today. To the extent that institutions have experienced losses, hold less capital, and are operating in a more risk-sensitive environment, supervisors expect banks to employ appropriate risk-management practices to ensure their viability. At the same time, it is important that supervisors remain balanced and not place unreasonable or artificial constraints on lenders that could hamper credit availability. As part of our effort to help stimulate appropriate bank lending, the Federal Reserve and the other federal banking agencies issued a statement in November 2008 to encourage banks to meet the needs of creditworthy borrowers. \2\ The statement was issued to encourage bank lending in a manner consistent with safety and soundness--specifically, by taking a balanced approach in assessing borrowers' ability to repay and making realistic assessments of collateral valuations. This guidance has been reviewed and discussed with examination staff within the Federal Reserve System.--------------------------------------------------------------------------- \2\ ``Interagency Statement on Meeting the Needs of Credit Worthy Borrowers,'' (November 2008).--------------------------------------------------------------------------- Earlier, in April 2007, the federal financial institutions regulatory agencies issued a statement encouraging financial institutions to work constructively with residential borrowers who are financially unable to make their contractual payment obligations on their home loans. \3\ The statement noted that ``prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term interest of both the financial institution and the borrower.'' The statement also noted that ``the agencies will not penalize financial institutions that pursue reasonable workout arrangements with borrowers who have encountered financial problems.'' It further stated that, ``existing supervisory guidance and applicable accounting standards do not require institutions to immediately foreclose on the collateral underlying a loan when the borrower exhibits repayment difficulties.'' This guidance has also been reviewed by examiners within the Federal Reserve System.--------------------------------------------------------------------------- \3\ ``Federal Regulators Encourage Institutions To Work With Mortgage Borrowers Who Are Unable To Make TheirPayments,'' (April 2007).--------------------------------------------------------------------------- More generally, we have directed our examiners to be mindful of the pro-cyclical effects of excessive credit tightening and to encourage banks to make economically viable loans, provided such lending is based on realistic asset valuations and a balanced assessment of borrowers' repayment capacities. Banks are also expected to work constructively with troubled borrowers and not unnecessarily call loans or foreclose on collateral. Across the Federal Reserve System, we have implemented training and outreach to underscore these objectives. ------ FOMC20080625meeting--73 71,MR. LOCKHART.," Thank you, Mr. Chairman. I would like to start with some anecdotal feedback from the region. As you know, we have a lot of Branches, so we have a lot of directors, and we ask our directors a lot of questions. The anecdotal feedback from our 44 directors about the second half can be characterized as subdued. Almost all reported that they expect economic activity to be flat or slower, and I took special note that these expectations deteriorated in June after having actually improved a bit in May. The residential housing situation in the District resembles the national picture. Both sales and new construction are weak. High levels of inventories are being exacerbated by foreclosures, which are adding to downward pressure on prices. However, there are tentative signs of a bottom forming. Our survey of Realtors across the District indicates that the pace of decline of single-family home sales may be abating. Industry contacts tell us that foot traffic and buyer interest are picking up, particularly in Florida, although I would say that what constitutes progress in Florida would not be considered very encouraging elsewhere. Nevertheless, our view is that the beginning of an adjustment process is under way, but the end of the process looks to be a long way off. Some further home-price deterioration is likely to accompany this bottoming process. Credit conditions in the District continue to tighten because of perceived risk and also liquidity pressure on our banks. Our banks indicate that the process of deleveraging continues, which is affecting lending for residential real estate and, to some extent, commercial real estate. We are also hearing from several sources that funding of community banks is becoming an increasing problem because of their previous dependence on wholesale and correspondent bank sources. Higher energy prices are, not surprisingly, affecting our outlook. Hospitality industry contacts, for instance, expressed concern about low summer bookings. Although most tourist destinations have reported solid activity to date, few expect this to continue. The reacceleration of energy and commodity price inflation has businesses focused on cost pressures. Several business contacts indicated that price increases had been relatively easy to pass through and make stick in this environment. I wouldn't say that it's widespread yet, but I do hear some reports that businesses are expecting wage increases to eventually reflect the recent increases in the cost of living. This could be a significant factor, particularly in service price inflation. This and other anecdotal input has colored my outlook for the national economy for the balance of the year and into 2009. I have revised up my forecast for headline inflation in 2008 and 2009 by 50 and 25 basis points, respectively. I am also assuming that the recent inflationary pressures from elevated energy and food prices will unwind more slowly than I previously projected--a view reinforced by expectations expressed by my District contacts. Like everyone else, I am deeply concerned that inflation expectations seem to be rising and that expectations of general price inflation, reflecting second-, third-, and fourth-order effects of recent oil and commodity price rises, risk becoming institutionalized. I am prepared in the near term to think tactically regarding the conflict between growth and employment policy objectives and inflation objectives; but sustained inflationary pressures that extend well into the fourth quarter and rising expectation readings may force, at least on my part, a more strategic look at the tradeoff. I would like to talk for a moment about financial markets. I made a number of calls during the intermeeting period, and the growth-versus-inflation tactical dilemma is complicated further by a very mixed picture in financial markets. My contacts all acknowledge improved conditions since mid-March, but discussion of the current market circumstances and the outlook had a sort of half-full/half-empty quality. My contacts, taken together, pointed to several positives, including the health of the corporate loan market, improved CDO pricing, the readiness of forming distressed funds to buy asset-backed securities, alt-A mortgage demand, the growing perception that subprime loss estimates have been overstated, and some comment on Goldman's Cheyne deal, which they believe will help create price determination for certain securities. At the same time, these contacts cited areas of continuing or worsening weakness, including: HELOCs and second mortgages; option ARMs and alt-A hybrids; indirect auto, given the collateral value of SUVs in current circumstances; in contrast to CDO pricing, CDO squared pricing is very weak and deteriorating; the obvious concern about the growing liquidity issues of regional banks; and the view that the auction rate securities market valuations, given illiquidity, are suggesting that this market has little probability of returning to normalcy. Overall, my contacts in financial markets were encouraged but expressed worries over still-substantial downside potential. Let me turn now to my national forecast compared with the Greenbook forecast. The Atlanta projections for the national economy are broadly similar to those of the Greenbook. We have the same general narrative of slow growth for the balance of the year followed by a gradual pickup through 2009 and 2010. My projections for headline and core inflation are virtually identical to the baseline Greenbook projections. However, I believe that there may be less disinflationary pressure than seems implicit in the Board staff's forecast. As a consequence, the fed funds rate path that supports my inflation outlook is well above the Greenbook's at the end of 2009 and 2010. We are 75 basis points higher at year-end 2009 and 100 basis points higher at year-end 2010. Notwithstanding the upward revision of the first-quarter GDP number and the better expectations for this quarter, I still believe the near-term risks to growth are weighted to the downside. At the same time, as suggested by my revised forecast, I see the risks to our inflation objective as weighted to the upside. On the subject of the long-term projections, I favor the third approach, which is three years plus long-term averages, and certainly would be comfortable with approach number 2. I'm generally dubious about the ability to do actual forecasting for the outyears, even as near-term as the third year. So I really don't favor approach number 1. My experience, in the brief time I have been with the Fed, has at least personally been, shall I say, challenging from the point of view of forecasting. I tend to think of the long-term projections as being roughly equivalent to our targets or policy goals. In fact, the approach we have generally taken with our three-year forecasts is making the outyear approaching at least what we would consider to be the trend rate for growth and the employment and inflation objective. So I think long-term projections really do amount to more-explicit targeting, and very likely the first question we get when we come out of the blocks--if we have this kind of approach--will be, Is this your target? I am comfortable saying ""yes"" to that question and, therefore, would support the third approach. Thank you, Mr. Chairman. " CHRG-110shrg50420--267 Mr. Wagoner," I think it is a fair question. My sense, Senator, is that right now the concern is very high, and so I think in the case that we put forth, we will be in need of funding soon. And so I think if people saw that funding coming, even with these conditions in front of it, and we would have to present a plan that we could convince people that we could execute it. But I think it would help vis-a-vis where we are today. Obviously, it would be best once it is all cleared. Senator Crapo. My time is running out. Let me ask just one more question. Frankly, I am just seeking a restatement, but my understanding is that I did not hear any objection from any of the three of you to the establishment of an oversight board, or whatever we call it, a Federal oversight entity that has the literal authority to impose restructuring conditions and to enforce those as a matter of law as these dollars are utilized. Am I correct? " FOMC20050322meeting--240 238,MS. SMITH.," I’m reading from page 25 of the Bluebook. The wording would be: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 2¾ percent.” And then B modified is: “The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”" CHRG-109shrg21981--200 Chairman Greenspan," Well, I think what President Gwynn was saying was obvious. We are not going to have the same statement in perpetuity. At some point, it is going to change. I cannot really comment on when and under what conditions because that is a decision that the Federal Open Market Committee has to make. " FOMC20071211meeting--96 94,MR. STERN.," Thank you, Mr. Chairman. It probably goes without saying that I think the main development since the last FOMC meting has been the renewed deterioration in some of the financial markets. In the absence of that—that is, had financial market conditions either stabilized or continued to improve as they had from the September to October meetings—we would be probably having a somewhat different conversation this morning. We would be talking more about parsing the recent incoming macro data and talking about whether the economy was slowing as anticipated or a little more or a little less. We should remember, we were expecting a significant slowing in the rate of growth, and that in fact does seem to be occurring. But, as I said, I think the financial market developments have been the dominant ones. As far as the economic outlook is concerned, my view of the next few quarters is for growth a bit better than that in the Greenbook for a couple of reasons. One is that I think the incoming data, as always, are noisy, and I am reluctant to put a lot of weight on them. Second, it seems to me that some of the underlying fundamentals, particularly the labor market data, present a more favorable picture of the outlook than the spending numbers at the moment. But it seems to me that the risks are clearly on the downside, and they are on the downside because of financial market conditions. Perhaps the most interesting anecdote I came across in the intermeeting period was that about two weeks ago we had a meeting with about fifteen leaders from firms in the financial services industry in the Twin Cities. There was a good deal of concern among, I would say, virtually all the participants in that meeting, and it wasn’t so much about year-end funding and that kind of thing. It was really about the economic outlook, and it had to do with the fact that some markets are not working or are barely working at the moment. There is no doubt that in their own businesses they are all tightening terms and other conditions. They believe that is appropriate, but they wouldn’t argue that it isn’t going to have an effect on spending. They also believe that at least some of their customers are acting in anticipation of that. That is, they are starting to cancel or at least delay spending plans, believing that they aren’t going to be able to find financing or at least find financing at terms they would like. So it seems to me that we are in an environment, as far as financial conditions are concerned, where that poses a very real downside threat to what otherwise might be a pretty acceptable economic outlook. Just a word about inflation. I haven’t changed my outlook for inflation going forward. I don’t have a sense from the incoming information that there is any compelling reason at the moment to do so. Thank you." FOMC20060920meeting--195 193,MS. DANKER.," I will be reading the language from page 25 of the Bluebook directive first. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” Then the risk assessment: “Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” Chairman Bernanke Yes Vice Chairman Geithner Yes Governor Bies Yes President Guynn Yes Governor Kohn Yes Governor Kroszner Yes President Lacker No Governor Mishkin Yes President Pianalto Yes Governor Warsh Yes President Yellen Yes" CHRG-111hhrg51698--122 Mr. Fortenberry," Thank you, Mr. Chairman, for holding this very important hearing and for delving very deeply into this complex issue, and I thank the panel as well for the lively and informative exchange. It has been very productive. When gasoline went over $4 in Nebraska last year, I stopped in to see Bill Sapp. He does something similar to you, Mr. Cota. Any of you who have gone down Interstate 80 right outside of Omaha might see a big coffee pot sitting 100 feet in the air. That is Bill's business. I said, Bill, what is going on, and he said, speculation. I want to follow up with your comments, Mr. Cota, talking last year when we hit $140 or so on oil futures, and now we are back down to $40. Your suggestion that this is being driven by greed and fear, being untethered from any supply or demand conditions, simply being accelerated because of artificial factors, outside, again, of the underlying fundamentals, led to such disruption not only in terms of gasoline prices, but all of the other commodities. And you, sir, had mentioned consequences for the other agricultural markets. If we presume that is true, and last year we held numerous hearings on this with the CFTC to figure out what systemically was potentially failing, where has regulation gone wrong. Their conclusion was we can't find a smoking gun, but we need more time and more help to potentially find a smoking gun. Let us unpack the reasons for, again, that rapid spike in speculation that everyone agrees has been terribly disruptive and not normal. Mr. Gooch, you alluded to it, to a portion of the reason, maybe the significant portion, in terms of credit and credit bubbles and investing in commodities as an inflationary hedge or for other reasons, because people were just getting on this accelerating train. If we can get to that underlying question, and then we know a lot more as to how to potentially prevent this type of systemic failure, disruption into the future, which has been, again, underlying a big portion in this economic malaise that we are in. " CHRG-111shrg55117--130 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System July 22, 2009 Chairman Dodd, Ranking Member Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress.Economic and Financial Developments in the First Half of 2009 Aggressive policy actions taken around the world last fall may well have averted the collapse of the global financial system, an event that would have had extremely adverse and protracted consequences for the world economy. Even so, the financial shocks that hit the global economy in September and October were the worst since the 1930s, and they helped push the global economy into the deepest recession since World War II. The U.S. economy contracted sharply in the fourth quarter of last year and the first quarter of this year. More recently, the pace of decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization. The labor market, however, has continued to weaken. Consumer price inflation, which fell to low levels late last year, remained subdued in the first 6 months of 2009. To promote economic recovery and foster price stability, the Federal Open Market Committee (FOMC) last year brought its target for the Federal funds rate to a historically low range of 0 to \1/4\ percent, where it remains today. The FOMC anticipates that economic conditions are likely to warrant maintaining the Federal funds rate at exceptionally low levels for an extended period. At the time of our February report, financial markets at home and abroad were under intense strains, with equity prices at multiyear lows, risk spreads for private borrowers at very elevated levels, and some important financial markets essentially shut. Today, financial conditions remain stressed, and many households and businesses are finding credit difficult to obtain. Nevertheless, on net, the past few months have seen some notable improvements. For example, interest rate spreads in short-term money markets, such as the interbank market and the commercial paper market, have continued to narrow. The extreme risk aversion of last fall has eased somewhat, and investors are returning to private credit markets. Reflecting this greater investor receptivity, corporate bond issuance has been strong. Many markets are functioning more normally, with increased liquidity and lower bid-asked spreads. Equity prices, which hit a low point in March, have recovered to roughly their levels at the end of last year, and banks have raised significant amounts of new capital. Many of the improvements in financial conditions can be traced, in part, to policy actions taken by the Federal Reserve to encourage the flow of credit. For example, the decline in interbank lending rates and spreads was facilitated by the actions of the Federal Reserve and other central banks to ensure that financial institutions have adequate access to short-term liquidity, which in turn has increased the stability of the banking system and the ability of banks to lend. Interest rates and spreads on commercial paper dropped significantly as a result of the backstop liquidity facilities that the Federal Reserve introduced last fall for that market. Our purchases of agency mortgage-backed securities and other longer-term assets have helped lower conforming fixed mortgage rates. And the Term Asset-Backed Securities Loan Facility (TALF), which was implemented this year, has helped restart the securitization markets for various classes of consumer and small business credit. Earlier this year, the Federal Reserve and other Federal banking regulatory agencies undertook the Supervisory Capital Assessment Program (SCAP), popularly known as the stress test, to determine the capital needs of the largest financial institutions. The results of the SCAP were reported in May, and they appeared to increase investor confidence in the U.S. banking system. Subsequently, the great majority of institutions that underwent the assessment have raised equity in public markets. And, on June 17, 10 of the largest U.S. bank holding companies--all but one of which participated in the SCAP--repaid a total of nearly $70 billion to the Treasury. Better conditions in financial markets have been accompanied by some improvement in economic prospects. Consumer spending has been relatively stable so far this year, and the decline in housing activity appears to have moderated. Businesses have continued to cut capital spending and liquidate inventories, but the likely slowdown in the pace of inventory liquidation in coming quarters represents another factor that may support a turnaround in activity. Although the recession in the rest of the world led to a steep drop in the demand for U.S. exports, this drag on our economy also appears to be waning, as many of our trading partners are also seeing signs of stabilization. Despite these positive signs, the rate of job loss remains high and the unemployment rate has continued its steep rise. Job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending. The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook. In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared economic projections covering the years 2009 through 2011. FOMC participants generally expect that, after declining in the first half of this year, output will increase slightly over the remainder of 2009. The recovery is expected to be gradual in 2010, with some acceleration in activity in 2011. Although the unemployment rate is projected to peak at the end of this year, the projected declines in 2010 and 2011 would still leave unemployment well above FOMC participants' views of the longer-run sustainable rate. All participants expect that inflation will be somewhat lower this year than in recent years, and most expect it to remain subdued over the next 2 years.Policy ChallengesMonetary Policy In light of the substantial economic slack and limited inflation pressures, monetary policy remains focused on fostering economic recovery. Accordingly, as I mentioned earlier, the FOMC believes that a highly accommodative stance of monetary policy will be appropriate for an extended period. However, we also believe that it is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation. \1\ The FOMC has been devoting considerable attention to issues relating to its exit strategy, and we are confident that we have the necessary tools to implement that strategy when appropriate.--------------------------------------------------------------------------- \1\ For further discussion of the Federal Reserve's ``exit strategy'' from its current policy stance, see ``Monetary Policy as the Economy Recovers'' in Board of Governors of the Federal Reserve System (2009), Monetary Policy Report to the Congress (Washington: Board of Governors, July), pp. 34-37.--------------------------------------------------------------------------- To some extent, our policy measures will unwind automatically as the economy recovers and financial strains ease, because most of our extraordinary liquidity facilities are priced at a premium over normal interest rate spreads. Indeed, total Federal Reserve credit extended to banks and other market participants has declined from roughly $1.5 trillion at the end of 2008 to less than $600 billion, reflecting the improvement in financial conditions that has already occurred. In addition, bank reserves held at the Fed will decline as the longer-term assets that we own mature or are prepaid. Nevertheless, should economic conditions warrant a tightening of monetary policy before this process of unwinding is complete, we have a number of tools that will enable us to raise market interest rates as needed. Perhaps the most important such tool is the authority that the Congress granted the Federal Reserve last fall to pay interest on balances held at the Fed by depository institutions. Raising the rate of interest paid on reserve balances will give us substantial leverage over the Federal funds rate and other short-term market interest rates, because banks generally will not supply funds to the market at an interest rate significantly lower than they can earn risk free by holding balances at the Federal Reserve. Indeed, many foreign central banks use the ability to pay interest on reserves to help set a floor on market interest rates. The attractiveness to banks of leaving their excess reserve balances with the Federal Reserve can be further increased by offering banks a choice of maturities for their deposits. But interest on reserves is by no means the only tool we have to influence market interest rates. For example, we can drain liquidity from the system by conducting reverse repurchase agreements, in which we sell securities from our portfolio with an agreement to buy them back at a later date. Reverse repurchase agreements, which can be executed with primary dealers, Government-sponsored enterprises, and a range of other counterparties, are a traditional and well-understood method of managing the level of bank reserves. If necessary, another means of tightening policy is outright sales of our holdings of longer-term securities. Not only would such sales drain reserves and raise short-term interest rates, but they also could put upward pressure on longer-term interest rates by expanding the supply of longer-term assets. In sum, we are confident that we have the tools to raise interest rates when that becomes necessary to achieve our objectives of maximum employment and price stability.Fiscal Policy Our economy and financial markets have faced extraordinary near-term challenges, and strong and timely actions to respond to those challenges have been necessary and appropriate. I have discussed some of the measures taken by the Federal Reserve to promote economic growth and financial stability. The Congress also has taken substantial actions, including the passage of a fiscal stimulus package. Nevertheless, even as important steps have been taken to address the recession and the intense threats to financial stability, maintaining the confidence of the public and financial markets requires that policy makers begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in the costs of Medicare and Medicaid. Addressing the country's fiscal problems will require difficult choices, but postponing those choices will only make them more difficult. Moreover, agreeing on a sustainable long-run fiscal path now could yield considerable near-term economic benefits in the form of lower long-term interest rates and increased consumer and business confidence. Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth.Regulatory Reform A clear lesson of the recent financial turmoil is that we must make our system of financial supervision and regulation more effective, both in the United States and abroad. In my view, comprehensive reform should include at least the following key elements: a prudential approach that focuses on the stability of the financial system as a whole, not just the safety and soundness of individual institutions, and that includes formal mechanisms for identifying and dealing with emerging systemic risks; stronger capital and liquidity standards for financial firms, with more-stringent standards for large, complex, and financially interconnected firms; the extension and enhancement of supervisory oversight, including effective consolidated supervision, to all financial organizations that could pose a significant risk to the overall financial system; an enhanced bankruptcy or resolution regime, modeled on the current system for depository institutions, that would allow financially troubled, systemically important nonbank financial institutions to be wound down without broad disruption to the financial system and the economy; enhanced protections for consumers and investors in their financial dealings; measures to ensure that critical payment, clearing, and settlement arrangements are resilient to financial shocks, and that practices related to the trading and clearing of derivatives and other financial instruments do not pose risks to the financial system as a whole; and improved coordination across countries in the development of regulations and in the supervision of internationally active firms. The Federal Reserve has taken and will continue to take important steps to strengthen supervision, improve the resiliency of the financial system, and to increase the macroprudential orientation of our oversight. For example, we are expanding our use of horizontal reviews of financial firms to provide a more comprehensive understanding of practices and risks in the financial system. The Federal Reserve also remains strongly committed to effectively carrying out our responsibilities for consumer protection. Over the past 3 years, the Federal Reserve has written rules providing strong protections for mortgage borrowers and credit card users, among many other substantive actions. Later this week, the Board will issue a proposal using our authority under the Truth in Lending Act, which will include new, consumer-tested disclosures as well as rule changes applying to mortgages and home equity lines of credit; in addition, the proposal includes new rules governing the compensation of mortgage originators. We are expanding our supervisory activities to include risk-focused reviews of consumer compliance in nonbank subsidiaries of holding companies. Our community affairs and research areas have provided support and assistance for organizations specializing in foreclosure mitigation, and we have worked with nonprofit groups on strategies for neighborhood stabilization. The Federal Reserve's combination of expertise in financial markets, payment systems, and supervision positions us well to protect the interests of consumers in their financial transactions. We look forward to discussing with the Congress ways to further formalize our institution's strong commitment to consumer protection.Transparency and Accountability The Congress and the American people have a right to know how the Federal Reserve is carrying out its responsibilities and how we are using taxpayers' resources. The Federal Reserve is committed to transparency and accountability in its operations. We report on our activities in a variety of ways, including reports like the one I am presenting to the Congress today, other testimonies, and speeches. The FOMC releases a statement immediately after each regularly scheduled meeting and detailed minutes of each meeting on a timely basis. We have increased the frequency and scope of the published economic forecasts of FOMC participants. We provide the public with detailed annual reports on the financial activities of the Federal Reserve System that are audited by an independent public accounting firm. We also publish a complete balance sheet each week. We have recently taken additional steps to better inform the public about the programs we have instituted to combat the financial crisis. We expanded our Web site this year to bring together already available information as well as considerable new information on our policy programs and financial activities. \2\ In June, we initiated a monthly report to the Congress (also posted on our Web site) that provides even more information on Federal Reserve liquidity programs, including breakdowns of our lending, the associated collateral, and other facets of programs established to address the financial crisis. \3\ These steps should help the public understand the efforts that we have taken to protect the taxpayer as we supply liquidity to the financial system and support the functioning of key credit markets.--------------------------------------------------------------------------- \2\ See ``Credit and Liquidity Programs and the Balance Sheet'' on the Board's Web site at www.federalreserve.gov/monetarypolicy/bst.htm. \3\ See the monthly reports on the Board's Web site at ``Credit and Liquidity Programs and the Balance Sheet'', Congressional Reports and Other Resources, Federal Reserve System Monthly Reports on Credit and Liquidity Programs and the Balance Sheet, www.federalreserve.gov/monetarypolicy/bst_reportsresources.htm.--------------------------------------------------------------------------- The Congress has recently discussed proposals to expand the audit authority of the Government Accountability Office (GAO) over the Federal Reserve. As you know, the Federal Reserve is already subject to frequent reviews by the GAO. The GAO has broad authority to audit our operations and functions. The Congress recently granted the GAO new authority to conduct audits of the credit facilities extended by the Federal Reserve to ``single and specific'' companies under the authority provided by section 13(3) of the Federal Reserve Act, including the loan facilities provided to, or created for, American International Group and Bear Stearns. The GAO and the Special Inspector General have the right to audit our TALF program, which uses funds from the Troubled Assets Relief Program. The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence. CHRG-111shrg55278--101 PREPARED STATEMENT OF SENATOR JIM BUNNING Thank you, Mr. Chairman. As I have said several times before, I do not think we can create a new regulator that will be able to outsmart Wall Street and prevent future financial failures. And I know the Federal Reserve is not up to the task. In fact, the Fed needs to be reformed so it can get monetary policy right and not create future bubbles through easy money. Instead of putting all our faith in a super regulator, I think we are better off taking steps to reduce the damage done by future failures. That means making financial institutions smaller, reducing risk factors like leverage, banning some risky practices, sound supervision, and making financial actors live with the consequences of their actions. That also means treating similar activities the same way no matter if they are done by a bank, broker, or other firm, and ending regulation shopping. If we do these things, we will greatly reduce the impact of future failures. Finally, of all the proposals we have seen, the one outlined in Chairman Bair's testimony today makes the most sense so far. While I think there are other matters that need to be addressed and I may not agree with everything she proposes, I think her plan is a better starting point than the proposal from Treasury and the Fed. Thank you, Mr. Chairman. I look forward to hearing from the witnesses today. ______ FOMC20080121confcall--54 52,MR. POOLE.," And you could add this sentence of explanation, ""President Poole does not believe that current market conditions justify policy action before the regularly scheduled meeting next week."" " FOMC20080916meeting--86 84,CHAIRMAN BERNANKE.," Has everyone a copy of that? Good. Before we get started on that, I just want to comment that we may want to say something in the statement about financial conditions, but we'll come back to that later. We need also now a vote to ratify the domestic open market operations. " CHRG-110hhrg38392--35 Mr. Green," Thank you, Mr. Chairman. I thank you for your judicious approach in managing the committee, and I am honored to associate myself with your comments, and I also thank the ranking member. Mr. Chairman, thank you for visiting with us today. I would like to visit with you very briefly about a crisis that continues, and it seems to go unabated, notwithstanding cyclical and temporary factors; notwithstanding excess inventories and the lack thereof; notwithstanding core inflation; commodity prices, whether they increase or flatten; notwithstanding energy prices and how they impact the economy; headline inflation, core inflation. We have a crisis, in my opinion, and we consistently find that one segment of our society has an unemployment rate that is always twice that of another segment of our society. White unemployment is, as of June 2007, 4.0 percent. Black unemployment is 8.5 percent. Poverty among whites is 10.4 percent. Poverty among blacks is 25.6 percent. This is not something that is anomalous. It occurs consistently. There is a trend that is easy to track, and we consistently find that black unemployment is always twice that of white unemployment and is likely to be twice that of the national unemployment. The trend is there. The poverty trend is there. The question that I have for you is similar to the one that the chairman posed, but it relates to this segment of society, and the question is: Do you see a change in this trend? Is it possible for us to have African American employment to achieve parity with white employment? Is this trend going to continue? " CHRG-110hhrg41184--88 Mr. Meeks," Thank you, Mr. Chairman. It is good to be with you, Chairman Bernanke. You know, sometimes you get some of these conditions, and you do one thing and it helps, you do something else and it hurts. And such is the situation that I think that we are currently in. It seems to me that if you move aggressively to cut interest rates and stimulate the economy, then you risk fueling inflation, on top of the fact that we have a weak dollar and a trade deficit. You know, you have to go into one direction or the other. Which direction are you looking at focusing on first? " FOMC20070918meeting--101 99,MS. YELLEN.," Thank you, Mr. Chairman. Readings on core inflation during the intermeeting period have continued to be encouraging, and the downward trend has persisted long enough that I’ve lowered my inflation forecast slightly. With the weaker outlook for growth, I also see less upside inflation risk emanating from cyclical pressures. With respect to economic activity, I’ve downgraded my forecast for growth in the fourth quarter by about the same amount as Greenbook and lowered it only marginally, a bit less than Greenbook, in 2008. The downside risks to this forecast are substantial and worrisome. The downward revision to my forecast reflects three factors: first, incoming data bearing on the outlook; second, my assessment of the likely impact of the financial shock that’s been unfolding since mid-July; third, the offsetting effect of the policy changes I consider appropriate in response to the first two forces. My forecast assumes that the fed funds rate will fall to about 4½ percent in the fourth quarter. In other words, my forecast is premised on timely actions by the Committee to mitigate much of the potential damage. Let me begin by commenting on the economic data that we have received since early August. Some has certainly been positive. Growth in the second quarter was revised upward, suggesting more momentum heading into the current quarter, and most indicators of consumer spending and business fixed investment were also robust. Like most observers, I’ve concluded that these data taken together support a small upward revision in my estimate of third-quarter growth. However, recent data on housing and forward-looking indicators relating to this sector suggest even greater weakness in residential investment than we previously anticipated. Manufacturing activity recently turned down, and importantly to me, the August employment report showed a marked deceleration in payroll employment growth over the past three months, suggesting that the financial shock hit an economy possessing quite a bit less momentum than I had factored into my previous forecast. Moreover, survey measures of consumer confidence are down, and these results probably do incorporate early effects from the recent financial shock. Of course, the most important factor shaping the forecast for the fourth quarter and beyond is the earthquake that began roiling financial markets in mid-July. Our contacts located at the epicenter—those, for example, in the private equity and mortgage markets—report utter devastation. Anecdotal reports from those nearby—for example, our contacts in banking, housing construction, and housing-related businesses—suggest significant damage from the temblor. For example, a large furniture retailer with stores in Utah and Nevada has seen sales fall off, and he has tightened credit terms for his customers and has already frozen his hiring and investment plans. In contrast, our business contacts operating further from the epicenter appear remarkably unfazed. Luckily for them and for us, the financial quake has thus far produced at most minor tremors in their businesses. This is not surprising. It is still too early to expect the ripple effects to be noticed by our contacts or to show up in the spending data. We could take a wait-and-see approach to the financial shock, incorporating its impact on our growth forecasts only after we observe its imprint in the spending data. But such an approach would be misguided and fraught with hazard because it would deprive us of the opportunity to act in time to forestall the likely damage. This means we must do our best to assess the likely effect of the shock. The simplest approach is to rely on our usual forecasting models. However, as David emphasized in his remarks, the shock has not affected to any great extent the financial variables that are typically included in our macro models. Since we last met, there have been only small net changes in broad equity indexes and the dollar. Of course, risk spreads in credit markets are up across a broad range of instruments and for most borrowers, both corporate and households. But there has been an offsetting drop in Treasury rates so that key rates appearing in our models—the interest rate on conforming mortgages and the interest rate facing prime corporate borrowers—are little changed or even slightly lower. It is riskier corporate borrowers and households seeking nonconforming mortgage loans, including jumbos, that have seen their borrowing rates rise over the past few months. But importantly, it is the drop in Treasury yields, about 50 to 100 basis points since early July, that has thus far shielded so many borrowers from higher interest rates, and of course, this drop reflects the market’s expectations that the Committee will ease the stance of monetary policy rather substantially. As I noted, my forecast assumes that we will plan to ease by around 75 basis points by year-end in line with market expectations. Even under this assumption, I see movements in interest rates alone as adding to a modest tightening of financial conditions. But, of course, an evaluation of the likely economic impact from the financial shock must also take into account changes in credit availability and lending terms even though these variables rarely appear explicitly in forecasting models. It is apparent that the availability of lending of some types, including subprime and alt-A mortgages, has diminished substantially or disappeared entirely. Moreover, banks and other financial institutions are imposing tighter terms and conditions across a broad range of corporate and household lending programs. For example, FICO cutoffs have been raised and maximum loan-to-value ratios lowered in many mortgage programs according to our contacts. In part, these changes reflect the pressures that banks and other financial intermediaries are experiencing in the context of severe illiquidity in secondary markets for nonconforming mortgages and other asset-backed securities, asset-backed commercial paper, and term loans in the interbank market. Many of the liquidity problems now afflicting banks and other financial market participants will presumably be resolved at least eventually, but it’s hard to believe that markets will return to business as usual as defined by conditions in the first half of this year even after that occurs. For one thing, many of the structured credit products that became so widely used may prove to be too complex to be viable going forward, and this would more or less permanently reduce the quantity of credit available to many risky borrowers. Moreover, if the financial intermediation that was routinely conducted via asset securitization and off-balance-sheet financing vehicles ultimately migrates back onto the books of the banks, borrowing spreads and lending terms are likely to remain tighter given current limitations on bank capital and the higher costs of conducting intermediation through the banking sector. Most important, the recent widening of spreads appears to reflect a return to more-realistic pricing of risk throughout the economy; this development may be positive for the long run, but it will be contractionary in the short run. Similar to the Greenbook, we’ve incorporated these financial developments into our projection by revising down our forecast for residential construction and home prices. But as we all know, housing is a small sector, so a major question is to what extent the financial shock will spread to other parts of the economy. We see a large drop in house prices as quite likely to adversely affect consumption spending over time through a number of different channels, including wealth effects, collateral effects, and negative effects on spending through the interest rate resets. A big worry is that a significant drop in house prices might occur in the context of job losses, and this could lead to a vicious spiral of foreclosures, further weakness in housing markets, and further reductions in consumer spending. Several alternative simulations in the Greenbook illustrate some of the unpleasant scenarios that could develop. A final concern is that the uncertainty associated with turbulent financial markets could make households and businesses more cautious about spending, causing some investment plans to be put on hold and some planned purchases of houses and consumer durables to be deferred. So at this point I am concerned that the potential effects of the developing credit crunch could be substantial. I recognize that there’s a tremendous amount of uncertainty around any estimate. But I see the skew in the distribution to be primarily to the downside, reflecting possible adverse spillovers from housing to consumption and business investment." FOMC20080310confcall--65 63,MR. LACKER.," Thank you, Mr. Chairman. As all of you know, throughout this episode I have opposed measures using our balance sheet to attempt to arrest credit market developments, and so it will come as no surprise that I oppose, respectfully, this measure as well--and for similar reasons. These measures are all aimed, one way or another, at altering the relative prices of some financial claims. I think the burden of proof ought to be on those who are advocating such measures to provide evidence of some sort of market failure. I have yet to see a plausible case for market failure that would warrant such intervention by a central bank here. In this case, I don't think the concerns raised by the New York staff memo really come close, and it strikes me that they could equally well rationalize buying tech stocks in late 2000. More broadly, our efforts to ameliorate credit market conditions appear to be motivated by the notion that exogenous malfunctions internal to credit markets endanger the real economy. But it seems much more plausible to me now that the credit market phenomena we have been seeing over the past year are driven entirely by the evolution of expectations regarding the fundamental real return on mortgages and other primitives. I have a deep concern that is particular to this proposal. This proposal crosses a bright line that we drew for ourselves in the 1970s in order to limit our involvement in housing finance. Legislators at that time were proposing various schemes that would involve using our balance sheet to fund various housing initiatives of one sort or another. In the current climate, legislators seem to be casting about for funds to bail out mortgage borrowers. Given the extent to which we have been singled out far more than any other federal regulators as scapegoats for this episode, it would be natural for them to contemplate raiding our portfolio--not to mention, in fact, that our portfolio is larger than other regulators' portfolios. Whatever one feels about the advisability of fiscal policy of that sort, I think the legal memo did a creative job of interpreting the Federal Reserve Act as allowing direct ownership of this form. But I think we should view opening up this sort of expansive interpretation of the act as a relatively irreversible step because it will be next to impossible to put this interpretation back in the bottle and argue that the act prevents us from holding particular mortgage-backed securities outright. Setting this precedent is going to measurably weaken our ability to resist congressional proposals to use us and our balance sheet for off-budget fiscal policy. So, again, Mr. Chairman, I respectfully oppose this term securities lending facility. " FOMC20071031meeting--68 66,MR. STERN.," Thank you, Mr. Chairman. There really have not been any significant changes in economic conditions or trends in the District. Moderate expansion is continuing. The special survey we did on financial conditions and whether the changes there had affected capital spending plans suggested that plans, at least for firms in our District, were largely unaffected. Contacts with insight into the shipping industry do report that exports are very strong, stronger than at least they had anticipated. That, of course, is consistent with what we have been seeing in some of the aggregate data. As far as the national economy is concerned, I agree with the Greenbook’s assessment of the incoming information that we received since the last Committee meeting. I won’t rehash it here, except to say that the surprises have been positive, a bit on the upside, and I think we still—at least at the aggregate level—haven’t seen generalized spillovers from the contraction in housing activity or prices on overall economic activity. I also agree with the Greenbook’s assessment of the outlook for the economy for the next two or three quarters. I think growth is likely to be subdued as a consequence of the changes in financial conditions that we’ve seen. As far as prices are concerned, core inflation seems to me to be relatively well contained at least on a year-over-year basis, and I expect that performance to be maintained as long as we pursue appropriate policy. Looking at the overall economic outlook beyond the next two or three quarters, I think there is a reasonable chance, given recent developments and recent actions, that by the middle of next year, say, we’ll be looking at real economic growth of something close to what the economy has averaged over the past six years—that is, the period 2002 through 2007. This is a bit more favorable, a bit higher, than the Greenbook outlook, and as best I can judge, the Greenbook is more conservative than I am about the nonconsumption, nonresidential investment components of aggregate demand. Put another way, those components add a bit less to aggregate demand in the Greenbook than I would expect. But my real point is that I don’t think it is a great stretch to see pretty respectable growth by the middle of next year. My reading of the projections package that was briefly discussed earlier suggests to me that at least some have the same view. Of course, that improvement could occur even sooner given the uncertainty associated with forecasting short-term perturbations in the economy. Thank you." CHRG-111hhrg58044--381 Mr. Cohen," Thank you, Mr. Chairman. I appreciate you allowing me to participate in this panel and for your co-sponsorship of the bill that we have introduced on credit reports, which I think is extremely important. First, I would like to ask Mr. Pratt and Ms. Fortney if you can help us. It has been reported that at a recent legislative hearing in Oregon, TransUnion Director of State Government Relations Eric Rosenberg said, ``At this point, we do not have any research to show any statistical correlation between what is in somebody's credit report and their job performance or their likelihood to commit fraud.'' Are you all familiar with that statement? " CHRG-111hhrg48674--36 The Chairman," The gentleman's time has expired. The response will have to come in writing. The gentleman from Texas, Dr. Paul. Dr. Paul. Thank you, Mr. Chairman. In my opening remarks, I mentioned that Title 31 gives the GAO authority to audit the Fed, except in the final conclusion they exempt the Federal Reserve and the FDIC and the Comptroller of the Currency, so there is no authority. If Congress ever wants to know what is going on, we have to change the U.S. Code. For instance, right now I think it would be important for us to know what our monetary authorities are thinking about and talking about and planning internationally, because this system isn't working, and the new system is going to be devised, and I am sure it has been discussed. I would like it know if there are plans for another pseudo-Bretton Woods agreement. It is very, very important to us. It is important to our sovereignty and important to our wellbeing, but we don't even have the right to know that as Members of Congress. In section 13(3), it gives you the authority, and you cite the authority, to make loans and bail out individuals, partnerships, and corporations. And it hasn't been used much, but it is there, and that is congressional responsibility. But, you know, transparency is one thing, and I want that because it would expose the system as to how it operates, but there is more to it than that. To me, it is the power, it is the power and the authority that gravitates to the hands of a small group of people who can create money out of thin air. This is an ominous power. It is the most powerful tool for central economic planning around, and that really has to be the issue as much as transparency. Once you have this power to control money and credit and centrally plan, you can distort contracts. So we are talking about distorting contracts, rewriting contracts when we get involved in these bailouts like we have been. But you know, Chairman Bernanke, you have written a lot about the Depression, and, of course, there was a famous quote that you made once to Milton Friedman about apologizing about the Federal Reserve bringing on and creating and prolonging the Depression, but you assured him it wouldn't happen again. The free-market people agree with you entirely; the Federal Reserve is responsible. But the irony of all of this, and the key to this discussion has to be, was it too much credit in the 1920's that created the conditions that demanded a recession, Depression, or was it lack of credit in the Depression that caused the prolongation? And that is the debate. Obviously, the free-market people say the Fed brought it on by too much credit in the beginning. But the question I have is the adjustment of real value of assets. The Federal Reserve brings on these crises by interfering with the cost of money and through interest rates and the supply of money, but here we are working frantically to keep prices up. Housing prices have to be up; we have to stimulate housing. To me, from a free-market perspective, we are doing exactly the opposite of what we should do. The prices of houses should drop. We have 19 million unoccupied houses. Now, why should we in Congress stimulate housing? What is so terribly wrong with the market dictating this? We are frantic today. We are offering a new $1.5 billion program to buy up toxic assets, and that is propping up prices. That is illiquid, they are worthless; let us get rid of them and get it over with, get the pain and suffering behind us. How long are we going to be locked into this idea that we have to be involved in this price fixing? What is wrong with allowing the market to allow these prices to adjust and go down quickly so we can all go back to work again? " CHRG-111shrg57319--552 Mr. Killinger," That was the plan. We just did not execute it because of changing market conditions. Senator Levin. I know, but on June 6, 2006, you are still planning on executing it. This was a plan that you shifted to in 2004 and 2005. So you did execute this for about a year, a year and a half. " CHRG-111shrg62643--11 Mr. Bernanke," Thank you. Chairman Dodd, Senator Shelby, and Members of the Committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. The economic expansion that began in the middle of last year is proceeding at a moderate pace, supported by stimulative monetary and fiscal policies. Although fiscal policy and inventory restocking will likely be providing less impetus to the recovery than they have in recent quarters, rising demand from households and businesses should help sustain growth. In particular, real consumer spending appears to have expanded at about a 2\1/2\-percent annual rate in the first half of this year, with purchases of durable goods increasing especially rapidly. However, the housing market remains weak, with the overhang of vacant or foreclosed houses weighing on home prices and construction. An important drag on household spending is the slow recovery in the labor market and the attendant uncertainty about job prospects. After 2 years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, a pace insufficient to reduce the unemployment rate materially. In all likelihood, a significant amount of time will be required to restore the nearly 8\1/2\ million jobs that were lost over 2008 and 2009. Moreover, nearly half of the unemployed have been out of work for longer than 6 months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers' employment and earnings prospects. In the business sector, investment in equipment and software appears to have increased rapidly in the first half of the year, in part reflecting capital outlays that had been deferred during the downturn and the need of many businesses to replace aging equipment. In contrast, spending on nonresidential structures--weighed down by high vacancy rates and tight credit--has continued to contract, though some indicators suggest that the rate of decline may be slowing. Both U.S. exports and U.S. imports have been expanding, reflecting growth in the global economy and the recovery of world trade. Stronger exports have in turn helped foster growth in the U.S. manufacturing sector. Inflation has remained low. The price index for personal consumption expenditures appears to have risen at an annual rate of less than 1 percent in the first half of the year. Although overall inflation has fluctuated, partly reflecting changes in energy prices, by a number of measures underlying inflation has trended down over the past 2 years. The slack in labor and product markets has damped wage and price pressures, and rapid increases in productivity have further reduced producers' unit labor costs. My colleagues on the Federal Open Market Committee and I expect continued moderate growth, a gradual decline in the unemployment rate, and subdued inflation over the next several years. In conjunction with the June FOMC meeting, Board members and reserve bank presidents prepared forecasts of economic growth, unemployment, and inflation for the years 2010 through 2012 and over the longer run. The forecasts are qualitatively similar to those we released in February and in May, although progress in reducing unemployment is now expected to be somewhat slower than we previously projected, and near-term inflation now looks likely to be a little lower. Most FOMC participants expect real GDP growth of 3 to 3\1/2\ percent in 2010, and roughly 3\1/2\ to 4\1/2\ percent in 2011 and 2012. The unemployment rate is expected to decline to between 7 and 7\1/2\ percent by the end of 2012. Most participants viewed uncertainty about the outlook for growth and unemployment as greater than normal, and the majority saw the risks to growth as weighted to the downside. Most participants projected that inflation will average only about 1 percent in 2010 and that it will remain low during 2011 and 2012, with the risks to the inflation outlook roughly balanced. One factor underlying the Committee's somewhat weaker outlook is that financial conditions--though much improved since the depth of the financial crisis--have become less supportive of growth in recent months. Notably, concerns about the ability of Greece and a number of other euro-area countries to manage their sizable budget deficits and high levels of public debt spurred a broad-based withdrawal from risk taking in global financial markets in the spring, resulting in lower stock prices and wider risk spreads in the United States. In response to these fiscal pressures, European leaders put in place a number of strong measures, including an assistance package for Greece and 500 billion euros of funding to backstop the near-term financing needs of euro-area countries. To help ease strains in U.S. dollar funding markets, the Federal Reserve reestablished temporary dollar liquidity swap lines with the ECB and several other major central banks. To date, drawing under the swap lines has been limited, but we believe that the existence of these lines has increased confidence in dollar funding markets, helping to maintain credit availability in our own financial system. Like financial conditions generally, the state of the U.S. banking system has also improved significantly since the worst of the crisis. Loss rates on most types of loans seem to be peaking, and in the aggregate, bank capital ratios have risen to new highs. However, many banks continue to have a large volume of troubled loans on their books, and bank lending standards remain tight. With credit demand weak and with banks writing down problem credits, bank loans outstanding have continued to contract. Small businesses, which depend importantly on bank credit, have been particularly hard hit. At the Federal Reserve, we have been working to facilitate the flow of funds to creditworthy small businesses. Along with the other supervisory agencies, we have issued guidance to banks and examiners emphasizing that lenders should do all they can to meet the needs of creditworthy borrowers, including small businesses. We also have conducted extensive training programs for our bank examiners, with the message that lending to viable small businesses is good for the safety and soundness of our banking system as well as for our economy. We continue to seek feedback from both banks and potential borrowers about credit conditions. For example, over the past 6 months we have convened more than 40 meetings around the country of lenders, small business representatives, bank examiners, Government officials, and other stakeholders to exchange ideas about the challenges faced by small businesses, particularly in obtaining credit. A capstone conference on addressing the credit needs of small businesses was held at the Board of Governors in Washington last week. This testimony includes an addendum that summarizes the findings of this effort and possible next steps. The Federal Reserve's response to the financial crisis and the recession has included several components. First, in response to the periods of intense illiquidity and dysfunction in financial markets that characterized the crisis, the Federal Reserve undertook a range of measures and set up emergency programs designed to provide liquidity to financial institutions and markets in the form of fully secured, mostly short-term loans. Over time, these programs helped to stem the panic and to restore normal functioning in a number of key financial markets, supporting the flow of credit to the economy. As financial markets stabilized, the Federal Reserve shut down most of these programs during the first half of this year and took steps to normalize the terms on which it lends to depository institutions. The only such programs currently open to provide new liquidity are the recently reestablished dollar liquidity swap lines with major central banks that I noted earlier. Importantly, our broad-based programs achieved their intended purposes with no loss to the taxpayers. All of the loans extended through the multiborrower facilities that have come due have been repaid in full, with interest. In addition, the Board does not expect the Federal Reserve to incur a net loss on any of the secured loans provided during the crisis to help prevent the disorderly failure of systemically significant financial institutions. A second major component of the Federal Reserve's response to the financial crisis and recession has involved both standard and less conventional forms of monetary policy. Over the course of the crisis, the FOMC aggressively reduced its target for the Federal funds rate to a range of 0 to \1/4\ percent, which has been maintained since the end of 2008. And as indicated in the statement released after the June meeting, the FOMC continues to anticipate that economic conditions--including low rates of resource utilization, subdued inflation trends, and stable inflation expectations--are likely to warrant exceptionally low levels of the Federal funds rate for an extended period. In addition to the very low Federal funds rate, the FOMC has provided monetary policy stimulus through large-scale purchases of longer-term Treasury debt, Federal agency debt, and agency mortgage-backed securities, or MBS. A range of evidence suggests that these purchases helped to improve conditions in mortgage markets and other private credit markets and put downward pressure on longer-term private borrowing rates and spreads. Compared with the period just before the financial crisis, the System's portfolio of domestic securities has increased from about $800 billion to $2 trillion and has shifted from consisting of 100 percent Treasury securities to having almost two-thirds of its investments in agency-related securities. In addition, the average maturity of the Treasury portfolio has nearly doubled, from 3\1/2\ years to almost 7 years. The FOMC plans to return the System's portfolio to a more normal size and composition over the longer term, and the Committee has been discussing alternative approaches to accomplishing that objective. One approach is for the committee to adjust its reinvestment policy--that is, its policy for handling repayments of principal on the securities--to gradually normalize the portfolio over time. Currently, repayments of principal from agency debt and MBS are not being reinvested, allowing the holdings of these securities to run off as the repayments are received. By contrast, the proceeds from maturing Treasury securities are being reinvested in new issues of Treasury securities with similar maturities. At some point, the committee may want to shift its reinvestment of the proceeds from maturing Treasury securities to shorter-term issues so as to gradually reduce the average maturity of our Treasury holdings toward pre-crisis levels, while leaving the aggregate value of those holdings unchanged. At this juncture, however, no decision to change reinvestment policy has been made. A second way to normalize the size and composition of the Federal Reserve's securities portfolio would be to sell some holdings of agency debt and MBS. Selling agency securities, rather than simply letting them run off, would shrink the portfolio and return it to a composition of all Treasury securities more quickly. FOMC participants broadly agree that sales of agency-related securities should eventually be used as part of the strategy to normalize the portfolio. Such sales will be implemented in accordance with a framework communicated well in advance and will be conducted at a gradual pace. Because changes in the size and composition of the portfolio could affect financial conditions, however, any decisions regarding the commencement or pace of asset sales will be made in light of the committee's evaluation of the outlook for employment and inflation. As I noted earlier, the FOMC continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the Federal funds rate for an extended period. At some point, however, the committee will need to begin to remove monetary policy accommodation to prevent the buildup of inflationary pressures. When that time comes, the Federal Reserve will act to increase short-term interest rates by raising the interest rate it pays on reserve balances that depository institutions hold at Federal reserve banks. To tighten the linkage between the interest rate paid on reserves and other short-term market interest rates, the Federal Reserve may also drain reserves from the banking system. Two tools for draining reserves from the system are being developed and tested and will be ready when needed. First, the Federal Reserve is putting in place the capacity to conduct large reverse repurchase agreements with an expanded set of counterparties. Second, the Federal Reserve has tested a term deposit facility, under which instruments similar to the certificates of deposit could be auctioned to depository institutions. Of course, even as the Federal Reserve continues prudent planning for the ultimate withdrawal of extraordinary monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain. We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our Nation's productive potential in a context of price stability. Last week, the Congress passed landmark legislation to reform the financial system and financial regulation, and the President signed the bill into law this morning. That legislation represents significant progress toward reducing the likelihood of future financial crises and strengthening the capacity of financial regulators to respond to risks that may emerge. Importantly, the legislation encourages an approach to supervision designed to foster the stability of the financial system as a whole as well as the safety and soundness of individual institutions. Within the Federal Reserve, we have already taken steps to strengthen our analysis and supervision of the financial system and systemically important financial firms in ways consistent with the new legislation. In particular, making full use of the Federal Reserve's broad expertise in economics, financial markets, payment systems, and bank supervision, we have significantly changed our supervisory framework to improve our consolidated supervision of large, complex bank holding companies, and we are enhancing the tools we use to monitor the financial sector and to identify potential systemic risks. In addition, the briefings prepared for meetings of the FOMC are now providing increased coverage and analysis of potential risks to the financial system, thus supporting the Federal Reserve's ability to make effective monetary policy and to enhance financial stability. Much work remains to be done, both to implement through regulation the extensive provisions of the new legislation and to develop the macroprudential approach called for by the Congress. However, I believe that the legislation, together with stronger regulatory standards for bank capital and liquidity now being developed, will place our financial system on a sounder foundation and minimize the risk of a repetition of the devastating events of the past 3 years. Thank you, Mr. Chairman. I would be pleased to respond to your questions. " CHRG-109hhrg31539--149 Mr. Bernanke," Well, in our short-term monetary policymaking, we are able to adjust for the conditions of fiscal policy, however they may be. I think fiscal issues are more important in the long-term sense because of the long-term obligations we have, for example, for entitlements. We have not found the fiscal situation to be a major impediment to our short-term management of monetary policy. " FinancialCrisisReport--85 In February 2007, WaMu senior managers discussed “how best to dispose” of $433 million in Long Beach performing second lien loans, due to “disarray” in the securitization market. 249 David Beck, head of WaMu’s Wall Street operation, wrote that securitizing the loans was “not a viable exit strategy” and noted: “Investors are suffering greater than expected losses from subprime in general as well as subprime 2nd lien transactions. As you know, they are challenging our underwriting representations and warrants. Long Beach was able to securitize 2nd liens once in 2006 in May. We sold the BBB- bonds to investors at Libor +260. To date, that transaction has already experienced 7% foreclosures.” 250 WaMu CEO Killinger complained privately to President Steve Rotella: “Is this basically saying that we are going to lose 15 [percent] on over $400 million of this product or 60 million. That is a pretty bad hit that reflects poorly on credit and others responsibility for buying this stuff. Is this showing up in hits to compensation or personnel changes.” 251 WaMu President Rotella responded: “This is second lien product originated 7-10 months ago from Long Beach. … In 2006 Beck’s team started sprinkling seconds in deals as they could. And, we now have the % down to the low single digits, so that we can sell all into our deals (assuming the market doesn’t get even worse).” He continued: “In terms of folks losing their jobs, the people largely responsible for bringing us this stuff are gone, the senior management of LB.” 252 Also in February 2007, early payment defaults again ticked up. A review of the first quarter of 2007 found: “First payment defaults (FPDs) rose to 1.96% in March but are projected to fall back to 1.87% in April based on payments received through May 5th.” 253 It also reported that the findings from a “deep dive into February FPDs revealed” that many of the problems could have been eliminated had existing guidelines been followed: “The root cause of over 70% of FPDs involved operational issues such as missed fraud flags, underwriting errors, and condition clearing errors. This finding indicates there may be opportunities to improve performance without further restricting underwriting guidelines.” 254 249 2/2007 email chain among WaMu personnel, JPM_WM00673101-03, Hearing Exhibit 4/13-17. 250 Id. at JPM_WM00673103. 251 Id. at JPM_WM00673101. 252 Id. 253 “Quarterly Credit Risk Review SubPrime,” prepared by WaMu Home Loans Risk Management (1st Quarter, 2007), Hearing Exhibit 4/13-18. 254 Id. FOMC20080625meeting--288 286,MR. STERN.," Thank you, Mr. Chairman. Just a few points. With regard to the shortterm plan of extending the facilities over the turn of the year and so forth--that is, the MOU and the testimony that goes with it--that is all fine with me. I don't have any problem with that. That sounds sensible under the circumstances. A number of important points have already been raised. I won't reiterate all of them. Maybe the one that caught my attention most completely was President Lacker's point about credibility. Whatever we go forward with obviously has to be seen as credible, and as he pointed out, it is important that at some point, to limit our involvement in supporting institutions and markets going forward, we may have to be prepared to let one large institution fail. The reason, of course, that we are very concerned about protecting them over time is the spillover effect. As I have said many times before, where we need to concentrate our efforts--not necessarily exclusively, but certainly in part--is in devising ways to limit spillovers. That is all about preparation--the analysis and so forth that goes with it--and it is all about communication--that is, putting uninsured creditors on notice that the regime is in fact in the process of changing. Now, having said that, I don't mean to suggest that it is easy. I don't mean to suggest that we will get it 100 percent correct. But if we don't do those kinds of things, then statements about boundaries aren't likely to be credible. They are just going to be, well, you guys wish it were this way, but you have section 13(3), and we know it's there, and we are going to act accordingly. So I think it is very important, as we go forward with this, that we focus some attention exactly on those areas. " CHRG-111shrg52619--164 PREPARED STATEMENT OF SENATOR JIM BUNNING Thank you, Mr. Chairman. This is a very important hearing, and I hope our witnesses will give us some useful answers. AIG has been in the news a lot this week, but it is not the only problem in our financial system. Other firms, including some regulated by our witnesses, have failed or been bailed out. We all want to make any changes we can that will prevent this from happening again. But before we jump to any conclusions about what needs to be done to prevent similar problems in the future, we need to consider whether any new regulations will really add to stability or just create a false sense of security. For example, I am not convinced that if the Fed had clear power to oversee all of AIG they would have noticed the problems or done anything about it. They clearly did not do a good enough job in regulating their holding companies, as we discussed at the Securities Subcommittee hearing yesterday. Their poor performance should throw cold water on the idea of giving them even more responsibility. Finally, I want to say a few words about the idea of a risk regulator. While the idea sounds good, there are several questions that must be answered to make such a plan work. First, we have to figure out what risk is and how to measure it. This crisis itself is evidence that measuring risk is not as easy as it sounds. Second, we need to consider what to do about that risk. In other words, what powers would that regulator have, and how do you deal with international companies? Third, how do we keep the regulator from always being a step behind the markets? Do we really believe the regulator will be able to recruit the talent needed to see and understand risk in an ever-changing financial system on government salaries? Finally, will the regulator continue the expectation of government rescue whenever things go bad? We should at least consider if we can accomplish the goal of a more stable system by making sure the parties to financial deals bear the consequences of their actions and thus act more responsibly in the first place. Thank you, Mr. Chairman. ______ CHRG-111shrg54589--145 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM HENRY T. C. HUQ.1.a. Do you believe the existence of an actively traded cash market is or should be a necessary condition for the creation of a derivative under law and regulation?A.1.a. Answer not received by time of publication.Q.1.b. If not, what specific, objective means besides a cash basis market could or should be used as the underlying relationship for a derivative?A.1.b. Answer not received by time of publication.Q.2. Why should the models to price OTC derivatives not be published? If there is no visible cash basis for a derivative, and the model is effectively the basis, why should the models not be public?A.2. Answer not received by time of publication.Q.3. What is the best way to draw the line between legitimate hedges and purely speculative bets? For example, should we require an insurable interest for purchasers of credit protection, require delivery of the reference asset, or something else?A.3. Answer not received by time of publication.Q.4. Is the concern that increased regulation of derivatives contracts in the United States will just move the business overseas a real issue? It seems to me that regulating the contracts written in the U.S. and allowing American firms to only buy or sell such regulated contracts would solve the problem. What else would need to be done?A.4. Answer not received by time of publication.Q.5. Do over-the-counter or custom derivatives have any favorable accounting or tax treatments versus exchange traded derivatives?A.5. Answer not received by time of publication.Q.6. In addition to the Administration's proposed changes to gain on sale accounting for derivatives, what other changes need to be made to accounting and tax rules to reflect the actual risks and benefits of derivatives?A.6. Answer not received by time of publication.Q.7. Is there any reason standardized derivatives should not be traded on an exchange?A.7. Answer not received by time of publication.Q.8. It seems that credit default swaps could be used to manipulate stock prices. In a simple example, an investor could short a stock, and then purchase credit default swaps on the company. If the swaps are not heavily traded, the purchase would likely drive up the price of the swaps, indicating higher risk of default by the company, and lead to a decline in the stock price. Is there any evidence that such manipulation has taken place? And more generally, what about other types of manipulation using derivatives?A.8. Answer not received by time of publication.Q.9. Credit default swaps look a lot like insurance when there are unbalanced, opportunistic sellers. However, life and property insurance requires an insurable interest for the buyer and reserves for the seller. Why should we not regulate these swaps like traditional insurance?A.9. Answer not received by time of publication.Q.10. How do we take away the incentive for credit default swap holders to force debtors into bankruptcy to trigger a credit event rather than renegotiate the debt?A.10. Answer not received by time of publication.Q.11. How do we reduce the disincentive for creditors to perform strong credit research when they can just buy credit protection instead?A.11. Answer not received by time of publication.Q.12. Do net sellers of credit protection carry that exposure on their balance sheet as an asset? If not, why shouldn't they?A.12. Answer not received by time of publication.Q.13. In her testimony Chairman Schapiro mentioned synthetic exposure. Why is synthetic exposure through derivatives a good idea? Isn't that just another form of leverage?A.13. Answer not received by time of publication.Q.14. Regarding synthetic exposure, if there is greater demand for an asset than there are available assets, why shouldn't the economic benefit of that demand--higher value--flow to the creators or owners of that asset instead of allowing a dealer to create and profit from a synthetic version of that asset?A.14. Answer not received by time of publication.Q.15. One of the arguments for credit default swaps is that they are more liquid than the reference asset. That may well be true, but if there is greater demand for exposure to the asset than there is supply, and synthetic exposure was not allowed, why wouldn't that demand lead to a greater supply and thus more liquidity?A.15. Answer not received by time of publication.Q.16. Is there any justification for allowing more credit protection to be sold on a reference asset than the value of the asset?A.16. Answer not received by time of publication.Q.17. Besides the level of regulation and trading on an exchange, there seems to be little difference in swaps and futures. What is the need for both? In other words, what can swaps do that forward contracts cannot?A.17. Answer not received by time of publication.Q.18. One of the arguments for keeping over-the-counter derivatives is the need for customization. What are specific examples of terms that need to be customized because there are no adequate substitutes in the standardized market? Also, what are the actual increased costs of buying those standard contracts?A.18. Answer not received by time of publication.Q.19. Who is a natural seller of credit protection?A.19. Answer not received by time of publication.Q.20. There seems to be agreement that all derivatives trades need to be reported to someone. Who should the trades be reported to, and what information should be reported? And is there any information that should not be made available to the public?A.20. Answer not received by time of publication.Q.21. What is insufficient about the clearinghouse proposed by the dealers and New York Fed?A.21. Answer not received by time of publication.Q.22. How do we prevent a clearinghouse or exchange from being too big to fail? And should they have access to Fed borrowing?A.22. Answer not received by time of publication.Q.23. What price discovery information do credit default swaps provide, when the market is functioning properly, that cannot be found somewhere else?A.23. Answer not received by time of publication.Q.24. Selling credit default swaps is often said to be the same as being long in bonds. However, when buying bonds, you have to provide real capital up front and there is a limit to the lending. So it sounds like selling swaps may be a bet in the same direction as buying bonds, but is essentially a highly leveraged bet. Is that the case, and if so, should it be treated that way for accounting purposes?A.24. Answer not received by time of publication.Q.25. Why should we have two regulators of derivatives, with two interpretations of the laws and regulations? Doesn't that just lead to regulation shopping and avoidance?A.25. Answer not received by time of publication.Q.26. Why is synthetic exposure through derivatives a good idea? Isn't that just another form of leverage?A.26. Answer not received by time of publication.Q.27. What is good about the Administration proposal?A.27. Answer not received by time of publication.Q.28. Is the Administration proposal enough?A.28. Answer not received by time of publication.Q.29. Mr. Whalen suggests that Congress should subject all derivatives to the Commodity Exchange Act, at least as an interim step. Is there any reason we should not do so?A.29. Answer not received by time of publication.Q.30. Is there anything else you would like to say for the record?A.30. Answer not received by time of publication. ------ fcic_final_report_full--434 The Commission heard convincing testimony of serious mortgage fraud prob- lems. Excruciating anecdotes showed that mortgage fraud increased substantially during the housing bubble. There is no question that this fraud did tremendous harm. But while that fraud is infuriating and may have been significant in certain ar- eas (like Florida), the Commission was unable to measure the impact of fraud rela- tive to the overall housing bubble. The explosion of legal but questionable lending is an easier explanation for the creation of so many bad mortgages. Lending standards were lax enough that lenders could remain within the law but still generate huge volumes of bad mortgages. It is likely that the housing bubble and the crisis would have occurred even if there had been no mortgage fraud. We therefore classify mortgage fraud not as an essential cause of the crisis but as a contributing factor and a deplorable effect of the bubble. Even if the number of fraudulent loans was not substantial enough to have a large im- pact on the bubble, the increase in fraudulent activity should have been a leading in- dicator of deeper structural problems in the market. Conclusions: • Beginning in the late s and accelerating in the s, there was a large and sustained housing bubble in the United States. The bubble was characterized both by national increases in house prices well above the historical trend and by more rapid regional boom-and-bust cycles in California, Nevada, Arizona, and Florida. • There was also a contemporaneous mortgage bubble, caused primarily by the broader credit bubble. • The causes of the housing bubble are still poorly understood. Explanations in- clude population growth, land use restrictions, bubble psychology, and easy fi- nancing. • The causes of the mortgage bubble and its relationship to the housing bubble are also still poorly understood. Important factors include weak disclosure standards and underwriting rules for bank and nonbank mortgage lenders alike, the way in which mortgage brokers were compensated, borrowers who bought too much house and didn’t understand or ignored the terms of their mortgages, and elected officials who over years piled on layer upon layer of gov- ernment housing subsidies. • Mortgage fraud increased substantially, but the evidence gathered by the Com- mission does not show that it was quantitatively significant enough to conclude that it was an essential cause. CHRG-111hhrg58044--339 Chairman Gutierrez," And I picked it right out of their information. It says, ``into an applicant's integrity and responsibility towards his or her financial obligation.'' Integrity and responsibility in character. You know, I find it astonishing that someone could predict or claim to predict, especially working men and women, their integrity and their responsibility is based on that. Ms. Chi Chi Wu, let me just ask you a question. You talked about a spiral. Could you talk about, ``I have bad credit, therefore I am denied a job?'' Tell me how that works. Ms. Wu. Well, it's very simple, and it's actually exactly as you described it in your opening statement. If you lose your job, you're not going to be able to pay your bills. You're going to fall behind on your credit card bills, maybe your mortgage, maybe your auto loan. Then you try to get a job. A potential employer runs a credit check and denies you a job. If you have bad credit, you can't get the job. And without income, you can't fix or improve your credit. So, it's just a vicious Catch-22. And it's societal, as well. That affects your ability to both build assets, your children's--what you could pass down to your children, and there are racial disparities. You know, the evidence cited that certain minority groups have lower credit scores, as a group. That--if credit scores are supposed to be an accurate translation of credit reports, what the industry claims it does, then you're talking about a huge disparate impact on these groups. And, you know, people don't start off at the same places. So a poor person who loses their job is less likely to have the assets to repay those bills than someone with more means and maybe a little savings when they lose their job. So it just makes things worse. " CHRG-110shrg50410--54 Secretary Paulson," I would just say one additional thing, because you are right. If and when--and again, there is no plans to do it. But if Government funds go in, then I think we need to look carefully at the ways to protect the taxpayer, the appropriate terms and conditions, and think all of that through. Senator Hagel. Well, the only comment I would make about that, then it is too late. " Mr. Chairman," " FOMC20080121confcall--15 13,MR. STERN.," Thank you, Mr. Chairman. I largely share your assessment of the situation and certainly support this action and taking it now. What has really caught my attention is the breadth of the weakness of the incoming data and the extent of the financial problems, some of which Bill Dudley covered. I don't have the sense at this point, given both the nature of the incoming data and the state of many of the financial markets we pay attention to, that there is a lot of latent or underlying strength in the economy. So that affects my view of the outlook as well, and I think it is important that we move aggressively, decisively, and in a timely way. Of course, the inflation numbers haven't been all that I might have hoped for, and even core inflation has been running a little higher than I thought it would. But even if we were in some sort of more formal inflation-targeting regime--and, of course, we are not--I have always assumed and always argued that, when you are confronting these kinds of conditions, you would deal with that situation as effectively as you can first and return to your inflation objective when conditions permitted. So I don't have any trouble taking such aggressive action at this point. " FOMC20080430meeting--116 114,MR. KROSZNER.," Thank you very much. As I have talked about many times before, I see what is happening as a continuing slow burn after the fires really heated up for a little while back in March. Things have cooled off again. But exactly as Governor Kohn said, we now seem to be comforted at levels that caused us extreme distress last fall and in January. So I think it is important to put it into that context. There certainly has been improvement, but it is a little early to declare victory--not that anyone has, but I think we just have to be very mindful of that. Some of the discussion reminds me a little of the discussions that we had at the end of October, when we thought that things were improving and then they deteriorated in a way that had us very concerned. But my central tendency scenario has always been not for a financial cataclysm, although that is certainly a real downside risk, but for a sort of slow burn that is just going to continue to weigh heavily on consumption. I think it is negative feedback between housing and finance, but not necessarily a broader cataclysm. I very much agree with President Evans that the chance of a significant nonlinear break to the downside is not gone but lower than it has been. But the tightening credit conditions are going to make it very difficult for the markets to repair and recover as rapidly as perhaps they do in the Greenbook. On housing, we know there are direct and indirect effects. We have all the signs that the contraction is continuing. Even after housing starts have fallen more than 60 percent, we are still seeing them in near free fall. But that hasn't helped to alleviate the inventories of unsold homes, which remain at extremely elevated levels--although not moving up dramatically. Part of the concern is that some of the sales may be due to forced sales related to foreclosures because we know that foreclosures are up quite a bit. So we have to be a bit cautious there. Almost all the measures suggest that expectations of future housing prices are lower, which is causing people to be very cautious about buying. The anecdotal evidence that I have is that walk-throughs are fine but that actually closing the deal is much more difficult, both because of difficulty in finding credit and because people are unwilling to make a commitment now. They think that prices may be 10 percent lower in 6, 9, or 12 months. For many people, this is the largest investment that they will make, and trying to explain to a loved one that they just lost 10 percent of their nest egg is not an easy thing to do. So people are being more cautious. We also see some of this in the ABX measures that Bill put forward. Those numbers have come off their extreme lows, but they are still much lower than they were before. It is hard to believe that the actual default and delinquency performance will be as bad as those measures are suggesting, but they are still suggesting that things are going to be pretty tough, and so we still need to be very wary there. We are still seeing a difference in consumer behavior--people being willing to walk away from their houses before they walk away from their credit cards or from their cars. That is suggesting that people are just operating somewhat differently from the way they did before. The jumbo spreads are still extremely wide, as the charts showed. We may be getting some offset from the new FHA programs and from Freddie Mac and Fannie Mae, but I am still not optimistic that much of this can come in before the end of the year. That suggests that we have tightness on that part. We also have tightness in the credit card market, exactly as Governor Warsh said. The credit card companies I have spoken to see continuing deterioration. We didn't see any sort of nonlinear changes but just a continuing downward trend of real challenges and increasing roll rates of people going 30, 60, 90, and more days delinquent. Spending is up a bit, but they usually say that's mostly because of increases for gasoline and groceries due to the high commodity prices. Also, as President Yellen mentioned, there is more tightening in the HELOC market. More challenges are there, so the banks are pulling back, and more people are getting into trouble. I have an anecdote from one of the large companies. A number of large investment-grade firms have drawn down significant parts of their revolvers, not because they actually needed them but because they thought that they better do it now before they are pulled back. Even these large institutions seem to be hoarding liquidity, much as the banks are doing. I think the banks are doing that because we still see CDS spreads that are very high even though they are lower than their peaks. The LIBOR�OIS spread that a number of people have mentioned still is high and is continuing to increase. That is the most troubling for me--that we are moving back to the extreme highs we saw when we had the end-of-the-year problem. But then we had an explanation for its going away. Now we don't have an end-of-the-year problem, so unfortunately, it is difficult for me to understand what is going to make this go away. I think we can provide more liquidity through some of our various facilities, but I am not sure that that, in and of itself, will be the cure. We have seen more capital come in and help out some of the institutions. But a lot of fragility is still there, as President Pianalto well knows. The issues with respect to National City were liquidity issues, not necessarily short-term concerns about solvency, although I think there are longer-term concerns about solvency. Liquidity and solvency issues are ultimately related, but there is a real concern that many of the money market mutual funds that hold between $3 trillion and $4 trillion will just walk away. We saw this with Bear Stearns. We can see this with other institutions. I think that it's fragility that accounts for some of these very high levels. We used to worry primarily about deposit runs, but deposit runs are extremely slow. Deposit runs are leisurely strolls compared with what could happen in these liquidity markets. So I do think that issues are there precisely because still more challenges are coming with commercial real estate construction, as a number of other people have mentioned. There will still be a lot of provisioning that will have to come up, putting more pressure on the balance sheets and making it more difficult for people to borrow. I also very much agree with Vice Chairman Geithner that the rest of the world is a little behind us and that the boost that we are getting right now from exports isn't going to persist. Turning to inflation, as I think a number of people have mentioned, we haven't seen a lot of pressure on the labor side. As labor markets soften, it is unlikely that we are going to see more pressure there. So that seems to be a positive. But we do see these very elevated commodity price levels, which don't seem to have fed through to core. But exactly as Governor Kohn said, it is a bit of a puzzle how they continue to increase, and that certainly puts some risks ahead of us. It is a particularly difficult time to get a good reading on inflation expectations because there have been lots of changes in liquidity issues and in other particular factors. Some of the survey-based measures are up, but they tend to be very closely related to gasoline prices, and we know that those are at extremely high levels. So I think it is extremely difficult for us now to make a solid determination about where inflation expectations are. Certainly that raises a caution because we don't want to have inflation expectations become unmoored. But I think it is more difficult for us to identify right now exactly how they are evolving, and obviously, this will be important for us in our decisions tomorrow. Thank you, Mr. Chairman. " CHRG-111hhrg58044--51 Mr. Wilson," It is on the credit report. " CHRG-111hhrg56767--110 Mr. Royce," How is paying out $6.3 million for the legal defense of former executives consistent with the conservatorship which requires you to preserve and conserve assets and property and to put the company in a sound and solvent condition? " CHRG-111hhrg48868--77 Mr. Clark," Right. And conditions wouldn't have been exactly the same at the time. So the answer might not have been exactly six notches, but it would have been in the range. But we have been saying for several months in our publications that we believe AIG's ratings would be non-investment grade had it not been for the support that had been provided. " FOMC20081216meeting--169 167,MR. COVITZ.," You could think about what the default risk is, say, for the corporate sector. You could break down a pretty simple model of defaults conditional upon our outlook for the economy, and that would have the default rate rising. " CHRG-111hhrg67816--150 Mr. Green," Our office has been hearing from constituents concerned that the free credit reports do not list all the information that credit lending entities have access to. Do you know if there is a case and, if so, do you believe consumers should have access to all this information? It seems that consumers should have access to all the credit information available to them. Have you heard of that or has that been an issue with the FTC? " FOMC20071211meeting--161 159,CHAIRMAN BERNANKE.," Thank you. Well, again, thank you, thank you all. I do think we need to move today. Once we take into account the drag from financial conditions, arguably the current rate is neutral or even somewhat restrictive. For example, the Taylor rules in the Bluebook have the neutral rate between 4 and 4¼ percent. Moreover, there has been quite a market change. Whether you look at markets or look at simulations, the FRB/US equilibrium real funds rate, for example, is down 70 basis points since the last meeting, which of course is just a summary of the revision of the forecast. On the other hand, you get similar numbers when you look at actual market indicators. So I think there is a sense in which our policies become de facto more restrictive and need to be addressed. On top of that, there is some case for insurance, although the discussion around the table illustrates that that is a complex idea when you, in fact, have a dual mandate and there are risks in both directions. If the choice were between 0 and 50 basis points, I would be very tempted to do 50 basis points. I think it would move us more toward accommodation, and it would be very pleasant to get the same kind of market response we got after September in terms of improved functioning and credit extension. That said, I think there are some risks to going with 50 basis points. I acknowledge what others have said, which is that it is not just about the rate but also about what the message is. In particular the markets already expect us to ease quite a bit more. We are not pushing strongly back against it with 25 basis points. If we do 50, we may be saying to the market that we are willing to do even more than you currently expect. I think that poses some risks to inflation expectations and poses some risks to the dollar, which is a little fragile right now. You can imagine it even having reverse effects with respect to the economy—for example, if it caused oil prices to jump or if it caused nominal interest rates to rise, thereby raising nominal mortgage rates. The other concern I have is that, for better or worse, given our communications and market expectations, at this point a 50 basis point cut would be viewed as something of a lurch and might signal, as others have suggested, more concern or private information about the economy that we in fact don’t necessarily have. You can tell that I am quite conflicted about it, and I think there is a good chance that we may have to move further at subsequent meetings. In that respect, it is very important that both in our statement and in our intermeeting communications that we signal our flexibility, our nimbleness: We are not locked in, we are responsive to conditions on both sides of the mandate, and we are alert to new developments. With all of that in mind—and although I don’t think the TAF is really a significant substitute for monetary policy, on the margin I think it is helpful—I recommend 25 basis points and alternative B. I did not hear much support for a downside risks sentence, and I agree that adding it would probably not very substantially affect the signal that we are sending today. So that is my proposal. Any comments? If not, could you please call the roll?" FOMC20070918meeting--197 195,VICE CHAIRMAN GEITHNER.," I didn’t mean to suggest not having anything that reflects the dispersion of views or the uncertainty around those views. But right now it’s so skeletal that it doesn’t add much value to the tables, and it gives in some ways less texture than what is in the minutes, frankly, about the outlook over time. If the central purpose of this is to animate the set of judgments about the evolution, we could do it a little better that way. This is complicated because we have all sorts of different conditioning assumptions that underpin our forecasts. When those conditioning assumptions vary, you can’t really tell much from what the variance in the forecast is. We don’t ask people to give a modal and an expected forecast and the difference between the two, even though we ask them about the balance of uncertainty in that sense. So it is hard in some sense, Mr. Chairman, but I didn’t mean to suggest you would want to do that because you want to try to force a consensus view." CHRG-111hhrg58044--50 Chairman Gutierrez," It is not used in your scores, but it is used in their credit reports. " FinancialCrisisInquiry--146 MAYO: I think the misallocation of capital in the housing market was partly facilitated by the GSEs. I personally have never covered Fannie and Freddie and those enterprises. There’s usually a separate set of analysts that covered those companies. But I think what we should have seen is the massive amount of capital that was allocated to the housing sector, government-incurred with a government guarantee, and that encouraged a whole industry off these government- sponsored entities. And that was a mistake, easy to say in hindsight. Many of us in the industry saw it for a while, and that goes back to the loan growth, some of the fastest growing areas, as I showed on my loan chart. I mean, every slice of real estate, you know, first mortgages, second mortgages, and then Wall Street certainly facilitated some of these activities. But you know what? Wall Street also met the demand. So it was kind of together—the government with Wall Street with the banks that facilitated this market. I made the general comment, I would prefer to see markets over government allocate capital, but with very strong oversight and regulation. VICE CHAIRMAN THOMAS: Mr. Chairman, I would yield the gentleman two additional minutes. HOLTZ-EAKIN: Thank you. I wanted to get Mr. Solomon’s reaction to the observation; I think it was Mr. Moynihan whose testimony walked through the mono-line institutions that failed during the crisis, and made the argument that it was in fact the large and diversified institutions that survived better, which seems to stand in contrast to a lot of the thrust of your argument about post-Gramm-Leach-Bliley activities. FOMC20081216meeting--222 220,MS. YELLEN.," Thank you, Mr. Chairman. In my view, cumulative recessionary dynamics are deeply entrenched, with mounting job losses leading to weaker consumer spending, tighter credit, more job losses, and so on; and this nasty set of economic linkages is gaining momentum. Like the Greenbook, I anticipate a long period of decline, and in fact, the consensus forecast is that we're now in the longest and one of the deepest postwar recessions. I hope that a recovery will begin in the middle of next year, but the risks seem skewed to the downside for several reasons. First, compared with the average recession, we face unusually difficult financial conditions. My contacts complain bitterly that even firms with sterling credit ratings have difficulty securing credit. Some banks appear reluctant to lend because financial markets are skeptical about the quality of their assets and their reported net worth. An accounting joke concerning the balance sheets of many financial institutions is now making the rounds, and it summarizes the situation as follows: On the left-hand side, nothing is right; and on the right-hand side, nothing is left. [Laughter] The second factor skewing risk to the downside is the unusually fearful and pessimistic psychology that's developed. One director, who heads a national department chain, predicts carnage in the retail sector after year-end, as stores close after trying to hold on through the holidays. Although some stores have been able to keep sales up to reasonable levels, heavy price discounting will translate into huge losses. Businesses have also generally turned very cautious, hoarding cash and slashing capital spending. A third factor that worries me is that, in contrast to many past recessions, this one is global in nature, and the fact that it's a worldwide slowdown--while lowering commodity prices, which is good--is also going to make it harder for us to pull out. Turning just very briefly to the labor market, the Beveridge curve chart that Stephanie presented during her briefing suggests that we have seen an unusually large increase in the unemployment rate recently in comparison with the decline in job openings, at least in the JOLTS data. I think one interpretation might be that the unemployment rate has risen in part because we have had an unusual rise in labor force participation during this recession. Labor force participation has been higher than would be expected, particularly for three demographic groups: young adults, married women, and older workers nearing retirement. Analysis by my staff estimates that this rise in participation could reflect behavioral responses to unusual credit constraints and wealth declines. Specifically, young adults aged 20 to 24 years appear to be entering the labor force in unusual numbers, and that might reflect diminished access to student loans. Similarly, more married women are entering the labor force, and that's a possible reflection of diminished access to home equity and credit card loans. Finally, an unusually large number of older workers are in the labor market, and that may reflect the negative wealth shock associated with the collapse of housing values and the plummeting stock market. All in all, I expect the anomalous increase in labor force participation to put continued upward pressure on the unemployment rate. With respect to inflation, developments since our October meeting have again lowered the outlook. I'm particularly concerned about the disinflationary effect of actual and prospective economic slack. During the postwar period, core PCE inflation has actually fallen at least � percentage point in every single year in which unemployment has averaged 7� percent or more. Given that in each of the next two years the unemployment rate is predicted to average at least 8 percent, it seems quite likely that by the end of 2010 core inflation will have fallen at least 1� percentage points. That creates a very real risk of deflation. So under these circumstances, I definitely believe that we should do everything in our power to stimulate aggregate demand. " FOMC20080130meeting--297 295,MR. WARSH.," Thank you, Mr. Chairman. I support alternative B for several reasons, not least of which because it actually seems to reasonably capture what we talked about yesterday. So I think it has that benefit. To state the obvious, we are in a very tough spot. There are clearly risks on both sides of the mandate, and for folks who are of differing opinions, I don't think that they would either deny the tough spot we're in or say that we have a lack of worries on either side. I think President Geithner said in the Q&A at the beginning of this round that we're choosing which policy error we're prepared to make or, more charitably, we're deciding where our worries are the greatest. It does strike me that alternative B does that reasonably well. To step back for just a minute, I think that the tough spot we're in is a function of issues that were very long in the making and will take a long time to work out. That probably has two implications. First, as to what Governor Kohn said, it's easy for me to feel more comfortable with our judgment by saying that we'll be able to undo it really, really soon; but if it is going to take a long time for this to work out, I don't want to take any false comfort in that. The other implication is that, when I say that this is long in the making, I mean particularly for financial institutions. It has taken them a long time to dig themselves into this hole for the credit-intermediation process to be as deeply disturbed as I take it to be at this point. So when I think about what policies we would make on the monetary policy front, I wouldn't want to excuse or somehow allow them to get off scot-free; by going with alternative B, I don't think that would be the case. Financial institutions have far more work to do than we have yet to do on monetary policy. I think they are further from recognizing where they need to get. That will take some time. In listening to other people's perspectives on the elixir of a 3 percent fed funds rate, I think it would be a nice luxury to give 3 percent a chance, but it's probably not practical for the following reasons. I have tried to convince myself that the monetary policy moves in the last nine or ten days were a one-time step-function change, by which we were setting a level based on where we think the real economy is, and we need to get back to normal monetary policymaking. I think dropping the word ""appreciable"" as in alternative B is one way to do so. The goal would be for monetary policy to get back to sort of normal business in tough times. Another point, just of commentary, is that, by taking this action along the lines of alternative B, it would be nice if we weren't going to be lowering the value implied by the markets of where the rate will end up. So my support of alternative B is nonetheless with this worry as well--that the markets might think that we have more-dramatic actions and that we will have to go lower longer than is currently implied. I don't mean to give them additional credit there, but I don't think that we have a great alternative. As to the point about market expectations, I would note that we will--and necessarily at some level should--during the course of our next several meetings disappoint market expectations, and that is not something I think we need to run from. I think that will be part of the discipline function, but this is probably not the right time to do it. As a final point, alternative B is consistent with the narrative that we've started based on the data we saw in mid-December, based on the Chairman's speech earlier this month, and based on our meetings over the past several weeks. It strikes me that it would be prudent at this time of financial stability risks and uncertainty in the markets for us not to add volatility--not to throw out a different nuance or try to be too clever. So while I have sympathy for some of the ideas and amendments that have been suggested in this discussion, we've come to a pretty tough place, as I said at the outset. It's a tough fork in the road. We should all feel to some degree uncomfortable about the choice we make, but the choice we're making today needs to be as clear as it can be. Even if we'd get some comfort in being a little cute, a little clever, and a little nuanced, I'm afraid we might be undoing some of the clear bet that we have to put on the table. So with that, I support alternative B as written. Thank you, Mr. Chairman. " CHRG-109hhrg22160--242 Mr. Greenspan," I said that because of the difficulty of making judgments as to how markets would behave when you are moving funds out of the U.S. treasury into a private account, even though it is forced savings--meaning, you can't do anything with it--and from a technical point you have not changed the national savings rate, have not changed the balance of supply and demand of securities, and have not therefore presumably affected the price level of bonds, there is still the issue of how that is perceived by the marketplace, which is not all that easy to make a judgment on. My general concern is that if we knew for sure that the contingent liabilities that now exist are viewed in the private marketplace as similar to the real debt of the federal government, then technically moving funds in a carve-out of the way that the President is talking about would have no effect on interest rates, no effect, indeed, which would then be an accounting system which would be based on accrued receipts. The problem is caused by the fact that we are running unified budget---- Mr. Moore of Kansas. Moving aside from the interest rates concern right now, which I understand is a huge concern, if we were to borrow $2 trillion or $1 trillion right now--and I am saying right now, over the next several years--to finance these partially private accounts and divert money out of present retirement benefits being paid to Social Security recipients, wouldn't that just pass a debt along to our children and grandchildren? And is that fair? " CHRG-110shrg46629--102 Chairman Bernanke," I agree entirely. On labor shortages, there is, I think, a very strong demand in this country for skilled workers. In particular, we hear from our contacts around the country how difficult it is to find people, not just Ph.D.'s, but people who are familiar with plumbing and welding and other kinds of what we used to think of and still think of as blue-collar type occupations. And so I think there is an enormous opportunity here, if we can help people acquire those skills, to help them obviously but also to lower the unemployment rate that the economy can sustain because we will change unskilled workers into people who can fill these spots. I think that is very important. With respect to the effect on inflation, the way I think about this is that the economy at a given time has a certain amount of normal potential output. If the Fed is too easy or other factors lead to increased aggregate demand, and that demand is exceeding the supply essentially, then you can get inflation pressures. And so the challenge for the Fed is always to balance supply and demand, to think about whether or not the level of demand that we are generating with our interest rate policies and with other policies, Government policies for example, is consistent with the underlying supply. It is not so much that a given level of employment is per se inflationary. But if the economy is overheating, one might see a temporary dip in unemployment reflecting the extra resource utilization associated with it. So we do not have a magic unemployment rate that we look at, say, that is too low or too high. What we try to do is look at the whole economy, look for sources of price pressure. Are firms finding it easy to raise prices? Are there indications that markets are very tight, both at the labor level and the product level? And we try to make a judgment about the balances of supply and demand and that helps to govern our thinking about this. The labor market, you mentioned 6 percent. The labor market changes a lot over time in terms of demographics, in terms of skills and education, in terms of job finding through the Internet and so on. And so that number is not a fixed number. We always have to think about how it might be changing over time. With respect to housing, I talked about that quite a little bit in my testimony. There is, at this point, a pretty substantial overhang of unsold new homes. So even if demand stabilizes, as we think it will soon, there is going to be a period of weakness as builders work down those inventories and reduce their construction. Housing has been subtracting from GDP growth over the last year about a percentage point. If demand stabilizes and builders begin to work down those inventories, we think that the drag, while still negative, will begin to diminish over time. And so that effect will begin to moderate. In the testimony we do mention housing as a downside risk. It is, of course, possible that declining housing values will cause consumers to spend less. It is possible that it might lead to fewer construction jobs. That might also have effects on the economy. But to this point we have not seen significant spillovers from the housing sector into other parts of the economy. Most of the rest of the economy is functioning at a pretty strong level. But that is obviously something we are very alert to, the possibility that the housing slowdown might have implications for other parts of the economy. " CHRG-109hhrg22160--233 Mr. Greenspan," It is one of the most difficult problems government has had, Congressman, in trying to address this particular question. And the reason is that it is not just a question, as we tend to do, create vehicles to save, such as 401(k)s or IRAs or the like, because what we really have to do is to get people to consume less of their income, because that is what savings is. If you don't consume less of your income and you are building up a 401(k), it is essentially saying that you just drew the funds from other forms of savings and you did not increase your aggregate amount of savings. So the issue really gets down to the question of how do you increase income relative to consumption. And that is not very easy for government to address per se. What we can do is find measures which will augment the growth rate in the economy, create incentives for growth and the like. But unless you impose some things such as a consumption tax, which economists have argued for, which I suspect has very little support in the Congress, it is difficult to see how you come to grips directly with that issue. I might add that the consumption tax issue arose essentially because there does not seem to be any other way to directly get at this issue. My suspicion is that the 1 percent savings rate, which is what it has been for the last year, is probably going to be the low point, and we will start to rise from here. But that has been my expectation for a number of years, and I can't honestly wish to guarantee it, because it is a very tricky issue to forecast. The bottom line, Congressman, is I really can't suggest anything which is significant, practical and usable to address this subject and just hope it cures itself, sooner rather than later. " FOMC20051101meeting--227 225,MS. DANKER.," I’m reading the directive wording from page 24 of the Bluebook: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 4 percent.” And the assessment of risk, unchanged from the September statement, is: “The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”" CHRG-110shrg50418--104 Chairman Dodd," I took a lot of time and I apologize. Senator Shelby. Senator Shelby. Thank you. All of you are here today because you realize, and I think a lot of us realize you are in dire circumstances. You wouldn't be here otherwise. But with both your market share declining and the overall market for automobiles contracting, why should we believe that your firms are capable of restructuring now when you were unable to do so under better conditions, more benign conditions? A lot of people think you have already failed, that your model has failed, that you are here to get life support. You have burned billions collectively, the three of you, the companies have earned billions and billions and billions of dollars in trying to turn around your industry. What would you do with the money if you were able to get a tranche of $25 billion, and I am sure if you got $25 billion, you would want 25 or 30 or 40 more. What would you do with it specifically, and how would you pay this money back to the taxpayer, which is a very important question for me? Mr. Wagoner, we will start with you. You are GM. " CHRG-110shrg50414--222 Mr. Bernanke," They would. What we are aiming at, of course, is the market, and it is not just those who participate who benefit or don't benefit. If prices go up generally, that will help the entire system. In fact, it will help the global system, you know, which strengthens financial conditions generally. Senator Bayh. Thank you, Mr. Chairman. " CHRG-111hhrg49968--7 Mr. Bernanke," Thank you, Mr. Chairman. Chairman Spratt, Ranking Member Ryan, and other members of the committee, I am pleased to have this opportunity to offer my views on current economic and financial conditions and on issues pertaining to the Federal budget. The U.S. economy has contracted sharply since last fall, with real gross domestic product having dropped at an average annual rate of about 6 percent during the fourth quarter of 2008 and the first quarter of this year. Among the enormous cost of the downturn is the loss of nearly 6 million jobs since the beginning of 2008. The most recent information on the labor market, the number of new and continuing claims for unemployment insurance through late May, suggests that sizeable job losses and further increases in unemployment are likely over the next few months. However, the recent data also suggests that the pace of economic contraction may be slowing. Notably, consumer spending, which dropped sharply in the second half of last year, has been roughly flat since the turn of the year, and consumer sentiment has improved. In coming months, household spending power will be boosted by the fiscal stimulus program. Nonetheless, a number of factors are likely to continue to weigh on consumer spending, among them the weak labor market, the declines in equity and housing wealth that households have experienced over the past 2 years, and the still-tight credit conditions. Activity in the housing market, after a long period of decline, has also shown some signs of bottoming. Sales of existing homes have been fairly stable since late last year, and sales of new homes seem to have flattened out in the past couple of monthly readings, though they remain at depressed levels. Meanwhile, construction of new homes has been sufficiently restrained to allow the backlog of unsold new homes to decline, a precondition for any recovery in homebuilding. Businesses remain very cautious and continue to reduce their workforces and their capital investments. On a more positive note, firms are making progress in shedding the unwanted inventories that they accumulated following last fall's sharp downturn in sales. The Commerce Department estimates that the pace of inventory liquidation quickened in the first quarter, accounting for a sizeable portion of the reported decline in real GDP during that period. As inventory stocks move into better alignment with sales, firms should become more willing to increase production. We continue to expect overall economic activity to bottom out and then to turn up later this year. Our assessments that consumer spending and housing demand will stabilize and that the pace of inventory liquidation will slow are key building blocks of that forecast. Final demand should also be supported by fiscal and monetary stimulus, and U.S. exports may benefit if recent signs of stabilization in foreign economic activity prove accurate. An important caveat is that our forecast also assumes continuing gradual repair of the financial system and an associated improvement in credit conditions. A relapse in the financial sector will be a significant drag on economic activity and could cause the incipient recovery to stall. I will provide a brief update on financial markets in a moment. Even after recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further. We expect that the recovery will only gradually gain momentum, and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, and the unemployment rate is likely to rise for a time, even after economic growth resumes. In this environment, we anticipate that inflation will remain low. The slack in resource utilization remains sizeable. And notwithstanding recent increases in the prices of oil and other commodities, cost pressures generally remain subdued. As a consequence, inflation is likely to move down some over the next year relative to its pace in 2008. That said, improving economic conditions and stable inflation expectations should limit further declines in inflation. Conditions at a number of financial markets have improved since earlier this year, likely reflecting both policy actions taken by the Federal Reserve and other agencies, as well as a somewhat better economic outlook. Nevertheless, financial markets and financial institutions remain under stress, and low asset prices and tight credit conditions continue to restrain economic activity. Among the markets where functioning has improved recently are those for short-term funding, including the interbank lending markets and the commercial paper market. Risk spreads in those markets appear to have moderated, and more lending is taking place at longer maturities. The better performance of short-term funding markets in part reflects the support afforded by Federal Reserve lending programs. It is encouraging that the private sector's reliance on the Fed's programs has declined as market stresses have eased, an outcome that was one of our key objectives when we designed these interventions. The issuance of asset-backed securities, backed by credit card, auto, and student loans, has also picked up this spring, and ABS funding rates have declined--developments supported by the availability of the Federal Reserve's Term Asset-Backed Securities Loan Facility, or TALF, as a market backstop. In markets for longer-term credit, bond issuance by nonfinancial firms has been relatively strong recently. And spreads between Treasury yields and rates paid by corporate borrowers have narrowed some, though they remain wide. Mortgage rates and spreads have also been reduced by the Federal Reserve's program of purchasing agency debt and agency mortgage-backed securities. However, in recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen. These increases appear to reflect concerns about large Federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight to quality flows, and technical factors relating to the hedging of mortgage holdings. As you know, last month, the Federal bank regulatory agencies released the results of the Supervisory Capital Assessment Program. The purpose of the exercise was to determine for each of the 19 U.S.-owned bank holding companies with assets exceeding $100 billion a capital buffer sufficient for them to remain strongly capitalized and able to lend to creditworthy borrowers, even if economic conditions over the next 2 years turn out to be worse than we currently expect. According to the findings of the SCAP exercise, under the more adverse economic outlook losses of the 19 bank holding companies would total an estimated $600 billion during 2009 and 2010. After taking account of potential resources to absorb those losses, including expected revenues, reserves, and existing capital cushions, we determined that 10 of the 19 institutions should raise, collectively, additional common equity of $75 billion. Each of the 10 bank holding companies requiring an additional buffer has committed to raise this capital by November 9th. We are in discussions with these firms on their capital plans, which are due by June 8th. Even in advance of those plans being approved, the 10 firms have among them already raised more than $36 billion of new common equity, with a number of their offerings of common shares being oversubscribed. In addition, these firms have announced actions that would generate up to an additional $12 billion of common equity. We expect further announcements shortly, as their capital plans are finalized and submitted to supervisors. The substantial progress these firms have made in meeting their required capital buffers and their success in raising private capital suggests that investors are gaining greater confidence in the banking system. Let me turn now to fiscal matters. As you are well aware, in February of this year, Congress passed the American Recovery and Reinvestment Act, or ARRA, a major fiscal package aimed at strengthening near-term economic activity. The package included personal tax cuts, increases in transfer payments intended to stimulate household spending, incentives for business investment, increases in Federal purchases, and Federal grants for State and local governments. Predicting the effects of these fiscal actions on economic activity is difficult, especially in light of the unusual economic circumstances that we face. For example, households confronted with declining incomes and limited access to credit might be expected to spend most of their tax cuts. But then again, heightened economic uncertainties and a desire to increase precautionary saving or pay down debt might reduce households' propensity to spend. Likewise, it is difficult to judge how quickly funds dedicated to infrastructure needs and other longer-term projects will be spent and how large any follow-on effects will be. The CBO has constructed a range of estimates of the effects of the stimulus package on real GDP and employment that appropriately reflects these uncertainties. According to the CBO's estimates, by the end of 2010, the stimulus package could boost the level of real GDP between about 1 percent and a little more than 3 percent and the level of employment by between roughly 1 million and 3.5 million jobs. The increases in spending and reductions in taxes associated with the fiscal package and the financial stabilization program, along with the losses in revenues and increases in income support payments associated with the weak economy, will widen the Federal budget deficit substantially this year. The administration recently submitted a proposed budget that projects the Federal deficit to reach about $1.8 trillion this fiscal year before declining to $1.3 trillion in 2010 and roughly $900 billion in 2011. As a consequence of this elevated level of borrowing, the ratio of Federal debt held by the public, to nominal GDP is likely to move up from about 40 percent before the onset of the financial crisis, to about 70 percent in 2011. These developments would leave the debt-to-GDP ratio at its highest level since the early 1950s, the years following the massive debt buildup during World War II. Certainly our economy and financial markets face extraordinary near-term challenges, and strong and timely actions to respond to these challenges are necessary and appropriate. Nevertheless, even as we take steps to address the recession and threats to financial stability, maintaining the confidence of the financial markets require that we, as a Nation, begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby boom generation and continued increases in medical costs. The recent projections from the Social Security and Medicare trustees show that, in the absence of programmatic changes, Social Security and Medicare outlays will together increase from about 8.5 percent of GDP today to 10 percent by 2020 and 12.5 percent by 2030. With the ratio of debt to GDP already elevated, we will not be able to continue borrowing indefinitely to meet these demands. Addressing the country's fiscal problems will require a willingness to make difficult choices. In the end, the fundamental decision that the Congress, the administration, and the American people must confront is how large a share of the Nation's economic resources to devote to Federal Government programs, including entitlement programs. Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run. In particular, over the longer term, achieving fiscal sustainability--defined, for example, as a situation to which the ratios of government debt and interest payments to GDP are stable or declining, and tax rates are not so high as to impede economic growth--requires that spending and budget deficits be well-controlled. Clearly, the Congress and the administration face formidable near-term challenges that must be addressed, but those near-term challenges must not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances. Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth. And let me close briefly with an update on the Federal Reserve's initiatives to enhance the transparency of our credit and liquidity programs. As I noted last month in my testimony before the JEC, I have asked Vice Chairman Kohn to lead a review of our disclosure policies, with the goal of increasing the range of information that we make available to the public. That group has made significant progress, and we expect to begin publishing soon a monthly report on the Fed's balance sheet and lending programs that will summarize and discuss recent developments and provide considerable new information concerning the number of borrowers at our various facilities, the concentration of borrowing, and the collateral pledged. In addition, the reports will provide quarterly updates of key elements of the Federal Reserve's annual financial statements, including information regarding the system open market account portfolio, our loan programs, and the special-purpose vehicles that are consolidated on the balance sheet of the Federal Reserve Bank of New York. We hope that this information will be helpful to the Congress and others with an interest in the Federal Reserve's actions to address the financial crisis and the economic downturn. We will continue to look for opportunities to broaden the scope of the information and supporting analysis that we provide to the public. Thank you, Mr. Chairman. [The statement of Ben Bernanke follows:] Prepared Statement of Hon. Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System Chairman Spratt, Ranking Member Ryan, and other members of the Committee, I am pleased to have this opportunity to offer my views on current economic and financial conditions and on issues pertaining to the federal budget. economic developments and outlook The U.S. economy has contracted sharply since last fall, with real gross domestic product (GDP) having dropped at an average annual rate of about 6 percent during the fourth quarter of 2008 and the first quarter of this year. Among the enormous costs of the downturn is the loss of nearly 6 million jobs since the beginning of 2008. The most recent information on the labor market--the number of new and continuing claims for unemployment insurance through late May--suggests that sizable job losses and further increases in unemployment are likely over the next few months. However, the recent data also suggest that the pace of economic contraction may be slowing. Notably, consumer spending, which dropped sharply in the second half of last year, has been roughly flat since the turn of the year, and consumer sentiment has improved. In coming months, households' spending power will be boosted by the fiscal stimulus program. Nonetheless, a number of factors are likely to continue to weigh on consumer spending, among them the weak labor market, the declines in equity and housing wealth that households have experienced over the past two years, and still-tight credit conditions. Activity in the housing market, after a long period of decline, has also shown some signs of bottoming. Sales of existing homes have been fairly stable since late last year, and sales of new homes seem to have flattened out in the past couple of monthly readings, though both remain at depressed levels. Meanwhile, construction of new homes has been sufficiently restrained to allow the backlog of unsold new homes to decline--a precondition for any recovery in homebuilding. Businesses remain very cautious and continue to reduce their workforces and capital investments. On a more positive note, firms are making progress in shedding the unwanted inventories that they accumulated following last fall's sharp downturn in sales. The Commerce Department estimates that the pace of inventory liquidation quickened in the first quarter, accounting for a sizable portion of the reported decline in real GDP in that period. As inventory stocks move into better alignment with sales, firms should become more willing to increase production. We continue to expect overall economic activity to bottom out, and then to turn up later this year. Our assessments that consumer spending and housing demand will stabilize and that the pace of inventory liquidation will slow are key building blocks of that forecast. Final demand should also be supported by fiscal and monetary stimulus, and U.S. exports may benefit if recent signs of stabilization in foreign economic activity prove accurate. An important caveat is that our forecast also assumes continuing gradual repair of the financial system and an associated improvement in credit conditions; a relapse in the financial sector would be a significant drag on economic activity and could cause the incipient recovery to stall. I will provide a brief update on financial markets in a moment. Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further. We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, and the unemployment rate is likely to rise for a time, even after economic growth resumes. In this environment, we anticipate that inflation will remain low. The slack in resource utilization remains sizable, and, notwithstanding recent increases in the prices of oil and other commodities, cost pressures generally remain subdued. As a consequence, inflation is likely to move down some over the next year relative to its pace in 2008. That said, improving economic conditions and stable inflation expectations should limit further declines in inflation. conditions in financial markets Conditions in a number of financial markets have improved since earlier this year, likely reflecting both policy actions taken by the Federal Reserve and other agencies as well as the somewhat better economic outlook. Nevertheless, financial markets and financial institutions remain under stress, and low asset prices and tight credit conditions continue to restrain economic activity. Among the markets where functioning has improved recently are those for short-term funding, including the interbank lending markets and the commercial paper market. Risk spreads in those markets appear to have moderated, and more lending is taking place at longer maturities. The better performance of short-term funding markets in part reflects the support afforded by Federal Reserve lending programs. It is encouraging that the private sector's reliance on the Fed's programs has declined as market stresses have eased, an outcome that was one of our key objectives when we designed our interventions. The issuance of asset-backed securities (ABS) backed by credit card, auto, and student loans has also picked up this spring, and ABS funding rates have declined, developments supported by the availability of the Federal Reserve's Term Asset-Backed Securities Loan Facility as a market backstop. In markets for longer-term credit, bond issuance by nonfinancial firms has been relatively strong recently, and spreads between Treasury yields and rates paid by corporate borrowers have narrowed some, though they remain wide. Mortgage rates and spreads have also been reduced by the Federal Reserve's program of purchasing agency debt and agency mortgage-backed securities. However, in recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen. These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-toquality flows, and technical factors related to the hedging of mortgage holdings. As you know, last month, the federal bank regulatory agencies released the results of the Supervisory Capital Assessment Program (SCAP). The purpose of the exercise was to determine, for each of the 19 U.S.-owned bank holding companies with assets exceeding $100 billion, a capital buffer sufficient for them to remain strongly capitalized and able to lend to creditworthy borrowers even if economic conditions over the next two years turn out to be worse than we currently expect. According to the findings of the SCAP exercise, under the more adverse economic outlook, losses at the 19 bank holding companies would total an estimated $600 billion during 2009 and 2010. After taking account of potential resources to absorb those losses, including expected revenues, reserves, and existing capital cushions, we determined that 10 of the 19 institutions should raise, collectively, additional common equity of $75 billion. Each of the 10 bank holding companies requiring an additional buffer has committed to raise this capital by November 9. We are in discussions with these firms on their capital plans, which are due by June 8. Even in advance of those plans being approved, the 10 firms have among them already raised more than $36 billion of new common equity, with a number of their offerings of common shares being over-subscribed. In addition, these firms have announced actions that would generate up to an additional $12 billon of common equity. We expect further announcements shortly as their capital plans are finalized and submitted to supervisors. The substantial progress these firms have made in meeting their required capital buffers, and their success in raising private capital, suggests that investors are gaining greater confidence in the banking system. fiscal policy in the current economic and financial environment Let me now turn to fiscal matters. As you are well aware, in February of this year, the Congress passed the American Recovery and Reinvestment Act, or ARRA, a major fiscal package aimed at strengthening near-term economic activity. The package included personal tax cuts and increases in transfer payments intended to stimulate household spending, incentives for business investment, increases in federal purchases, and federal grants for state and local governments. Predicting the effects of these fiscal actions on economic activity is difficult, especially in light of the unusual economic circumstances that we face. For example, households confronted with declining incomes and limited access to credit might be expected to spend most of their tax cuts; then again, heightened economic uncertainties and the desire to increase precautionary saving or pay down debt might reduce households' propensity to spend. Likewise, it is difficult to judge how quickly funds dedicated to infrastructure needs and other longer-term projects will be spent and how large any follow-on effects will be. The Congressional Budget Office (CBO) has constructed a range of estimates of the effects of the stimulus package on real GDP and employment that appropriately reflects these uncertainties. According to the CBO's estimates, by the end of 2010, the stimulus package could boost the level of real GDP between about 1 percent and a little more than 3 percent and the level of employment by between roughly 1 million and 3\1/2\ million jobs. The increases in spending and reductions in taxes associated with the fiscal package and the financial stabilization program, along with the losses in revenues and increases in income-support payments associated with the weak economy, will widen the federal budget deficit substantially this year. The Administration recently submitted a proposed budget that projects the federal deficit to reach about $1.8 trillion this fiscal year before declining to $1.3 trillion in 2010 and roughly $900 billion in 2011. As a consequence of this elevated level of borrowing, the ratio of federal debt held by the public to nominal GDP is likely to move up from about 40 percent before the onset of the financial crisis to about 70 percent in 2011. These developments would leave the debt-to-GDP ratio at its highest level since the early 1950s, the years following the massive debt buildup during World War II. Certainly, our economy and financial markets face extraordinary near-term challenges, and strong and timely actions to respond to those challenges are necessary and appropriate. Nevertheless, even as we take steps to address the recession and threats to financial stability, maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in medical costs. The recent projections from the Social Security and Medicare trustees show that, in the absence of programmatic changes, Social Security and Medicare outlays will together increase from about 8\1/2\ percent of GDP today to 10 percent by 2020 and 12\1/2\ percent by 2030. With the ratio of debt to GDP already elevated, we will not be able to continue borrowing indefinitely to meet these demands. Addressing the country's fiscal problems will require a willingness to make difficult choices. In the end, the fundamental decision that the Congress, the Administration, and the American people must confront is how large a share of the nation's economic resources to devote to federal government programs, including entitlement programs. Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run. In particular, over the longer term, achieving fiscal sustainability--defined, for example, as a situation in which the ratios of government debt and interest payments to GDP are stable or declining, and tax rates are not so high as to impede economic growth--requires that spending and budget deficits be well controlled. Clearly, the Congress and the Administration face formidable near-term challenges that must be addressed. But those near-term challenges must not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances. Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth. federal reserve transparency Let me close today with an update on the Federal Reserve's initiatives to enhance the transparency of our credit and liquidity programs. As I noted last month in my testimony before the Joint Economic Committee, I asked Vice Chairman Kohn to lead a review of our disclosure policies, with the goal of increasing the range of information that we make available to the public.\1\ That group has made significant progress, and we expect to begin publishing soon a monthly report on the Fed's balance sheet and lending programs that will summarize and discuss recent developments and provide considerable new information concerning the number of borrowers at our various facilities, the concentration of borrowing, and the collateral pledged. In addition, the reports will provide quarterly updates of key elements of the Federal Reserve's annual financial statements, including information regarding the System Open Market Account portfolio, our loan programs, and the special purpose vehicles that are consolidated on the balance sheet of the Federal Reserve Bank of New York. We hope that this information will be helpful to the Congress and others with an interest in the Federal Reserve's actions to address the financial crisis and the economic downturn. We will continue to look for opportunities to broaden the scope of the information and supporting analysis that we provide to the public.--------------------------------------------------------------------------- \1\ Ben S. Bernanke (2009), ``The Economic Outlook,'' statement before the Joint Economic Committee, U.S. Congress, May 5, www.federalreserve.gov/newsevents/testimony/bernanke20090505a.htm. " FOMC20081216meeting--268 266,CHAIRMAN BERNANKE.," Other questions? I think it might be helpful to flag just a few things about which I would particularly appreciate the Committee's advice. The first is the issue that President Plosser was discussing, which is alternative A--not specifying a range or a target--or alternative B--specifying a range. I think that the argument for specifying a range is that it seems a little clearer. If you look at, for example, the Japanese experience, even when they were in quantitative easing, they still had a target for the call rate, as I understand it. There are some counter-arguments, which Governor Duke and others have raised, about the impact on banks and so on. That is question number 1. Question number 2--and this doesn't preclude other points, of course--is that in paragraph 3 of alternative B, for example, we have bracketed just for your reference the risk of inflation's declining below optimal levels. I would be interested to know your views on whether or not to include that bracketed phrase. Third--again looking at alternative B--in paragraph 4 we have the conditional statement that ""weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate."" A little informal polling suggested that people were sort of okay with this way of stating the conditionality. But if there are any concerns about that or, alternatively, if you would like to include a reference to disinflation as one of the conditions, that is just something I want to flag as a question. A fourth and final point I want to flag--and President Yellen pointed this out to me--in paragraph 5 we have a sentence saying that ""the Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities."" I think to put that in there we should feel that sometime in the next few meetings there is a significant chance that we would in fact engage in some kind of a program. We don't want to put it in there if it is a complete red herring. So those are four points that I have, but of course, you may have other questions or issues that you want to raise. Governor Duke. " FOMC20060808meeting--148 146,MS. SMITH.," Yes. The directive would be, “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” Then the risk assessment is, “Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth as implied by incoming information.” Chairman Bernanke Yes Vice Chairman Geithner Yes Governor Bies Yes President Guynn Yes Governor Kohn Yes Governor Kroszner Yes President Lacker No President Pianalto Yes Governor Warsh Yes President Yellen Yes" FOMC20070918meeting--132 130,MR. MADIGAN.,"3 Thank you, Mr. Chairman. To guard against the contingency that our security procedures have broken down and the Committee’s policy drafts are being monitored by unknown forces, the staff has taken countermeasures by circulating multiple drafts of table 1. [Laughter] Of the two drafts circulated this morning, I will be referring to the draft labeled, perhaps too obviously, September 18, 2007. To summarize, alternatives A and B would both reduce the target federal funds rate 50 basis points today to 4¾ percent but would differ in their risk assessment. Alternative A would conclude that, even after the 50 basis point easing, the downside risks to growth would outweigh the upside risks to inflation, whereas alternative B elides an assessment of the balance of risks but cites heightened uncertainty about the outlook. Alternative C reduces rates 25 basis points and describes the risks as tilted to the downside. Alternative D leaves the stance of policy unchanged but would characterize the risks to growth and inflation as now balanced. Based on your remarks this morning and the proposals by nearly all the Reserve Banks to reduce the primary credit rate, it seems likely that most or all of you favor some easing in the stance of policy today. Thus, the questions this morning would seem to be how much to reduce rates as well as the rationale for that action and the type of forward-looking language to provide. The modal outlook in the staff’s Greenbook forecast would seem to argue clearly for policy easing before long. The staff has interpreted recent financial developments as likely to inflict an appreciable and fairly immediate adverse shock on aggregate demand. As Dave noted, real GDP growth is projected to slow to 1 percent in the fourth quarter and to remain nearly that sluggish in the first quarter. The economy skirts recession, but real activity expands only 1¾ percent next year, less than potential, so modest slack emerges, and the unemployment rate rises to nearly 5 percent, a bit above the staff’s downward-revised estimate of the NAIRU. This slack contributes to an edging down of core inflation to just under 2 percent, and declines in energy prices help push total PCE inflation down to 1¾ percent next year. Beyond next year, real growth gradually strengthens to around its potential rate. As I noted earlier today, the central tendencies of your out-year projections suggest that most of you would find a PCE inflation rate leveling out in the vicinity of 1¾ percent, in conjunction with economic growth returning to a potential rate of around 2½ percent—a rate a bit higher than estimated by the staff—to be an appealing outcome. Of course, while you may be satisfied with such an outcome, the key question is what monetary policy path would be most likely to produce it. In the staff’s baseline assessment, a 50 basis point easing in the federal funds rate over the next few months sufficiently cushions the blow of the current financial shock to keep the expansion going in coming quarters while still allowing inflation to settle down to rates that 3 Materials used by Mr. Madigan are appended to this transcript (appendix 3). most of you evidently would find consistent with price stability. If your own modal outlook is similar to the staff’s baseline assessment, you might find the selection of any of alternatives A, B, or C at this meeting to be appropriate. An immediate 50 basis point reduction, as in alternatives A and B, would accelerate the drop in the actual federal funds rate by just a month or two relative to the Greenbook. A 25 basis point easing today coupled with an assessment that the risks are tilted to the downside, as in alternative C, and an expectation on your part that another easing would likely be forthcoming would also be essentially consistent with the staff outlook. Thus, your choices among those three approaches might depend importantly on risk-management considerations. Several of the Greenbook alternative simulations explore the possibility that policy might need to be eased more aggressively. In the “greater housing correction” scenario, the subprime mortgage market is assumed to remain closed over the entire projection period rather than to recover partially as in the baseline, and housing prices decline 20 percent over the next two years, rather than just a few percent. In such circumstances, aggregate demand weakens considerably below baseline, and the Taylor rule suggests that the funds rate should gradually be eased to 4¼ percent by 2009. The “greater housing correction with larger wealth effect” scenario, in which the effects of the greater housing contraction are augmented by a larger sensitivity of household spending to household wealth, points to an even greater easing. Another possibility is that forced acquisition by banks of large volumes of ABCP, leveraged loans, and other assets erodes their capital ratios, bringing them closer to regulatory thresholds and benchmarks negotiated with rating agencies, and that banks respond by tightening credit terms and standards. Partly because episodes featuring sharp changes in credit availability are relatively rare, assessing these effects is fraught with uncertainty. But the “bank capital crunch” scenario in the Greenbook, which was based loosely on the early 1990s headwinds episode, suggests that policy might need to be eased significantly and quickly, with the funds rate dipping to 3¼ percent by June. If Committee members are inclined to put appreciable weight on the possibility that something resembling any of these three scenarios could transpire, they might be inclined toward alternative A—an immediate reduction in the funds rate of 50 basis points at this meeting coupled with an assessment that the risks remain tilted to the downside. The effects of a preemptive easing of policy—working through the standard transmission channels of lower long-term yields, a lower exchange value of the dollar, and higher equity prices and household wealth—might help cushion the economy from a sharp weakening of aggregate demand. In current circumstances, a relatively aggressive easing of policy and the sense that more could be coming if needed might be particularly helpful in thawing financial markets or at least in preventing a harder freeze and thus might work importantly through credit channels as well as directly through open market prices. A relatively large and immediate reduction in the federal funds rate might go some considerable distance toward alleviating concerns on the part of market participants regarding further erosion in the value of assets held as collateral. It might also be seen by investors as a signal that the Federal Reserve will act forcefully to sustain economic growth, helping to limit lenders’ concerns about losses. By reducing the fears of market participants and bankers about counterparty credit exposures and credit risks more generally—or at least helping to prevent them from worsening—a prompt and sharp easing of policy might help avert a significant tightening in credit terms and standards and thus sustain growth in aggregate demand. In this way, monetary policy might be directed proximately at improving the functioning of financial markets but ultimately at the Committee’s longer-run objectives. This argument is easy both to misconstrue and to exaggerate—easy to misconstrue because it may appear that policy is responding directly to asset prices and easy to exaggerate because policy easing cannot do much to dispel the fundamental economic losses already in train, for example, on subprime mortgage investments. But it may be able to help prevent them from contributing to a cumulative weakening of activity that would increase credit risks more generally and feed back adversely onto growth. On the other hand, the Committee may not be persuaded that the hit to aggregate demand will be as severe as projected by the staff in its baseline forecast, let alone in the weaker alternative simulations in the Greenbook. Members may feel that at least some of the history of financial crises over the past two decades suggests that financial markets can bounce back fairly quickly once the immediate crisis has passed and that the real economy can be surprisingly resilient in the face of temporary financial disruptions. Both 1987 and 1998 come to mind, as was pointed out previously, as episodes in which, at least arguably, the restraining effects of financial events on the domestic economy were not nearly as severe as policymakers feared. A separate point is that many of you see potential GDP growth as a bit more robust than the staff, suggesting that you may also see equilibrium real short-term interest rates as a bit higher. Coming back to the near-term outlook for aggregate demand, even if you think that the staff may be right about the likely degree of forthcoming financial restraint, you may be quite uncertain on that score. Any of these arguments may motivate you to consider the approach of alternative C. Under that alternative, you would ease 25 basis points today and issue a statement that characterizes the downside risks to growth as outweighing the upside risks to inflation. Such an assessment would position you well to respond to incoming signs of economic weakness, should they appear, by easing policy at some point over the next meeting or two. This approach might also be seen as advantageous if you are particularly concerned that the Committee would find it difficult to quickly reverse easing moves that subsequently proved to be unnecessary. You might also prefer a 25 basis point rate cut for now if you are concerned that investors could misread a 50 basis point easing as a sign that the Committee was responding directly to asset prices, potentially exacerbating moral hazard by encouraging excessive risk-taking. Alternative B may be seen as the middle ground between alternatives A and C. Alternative B would adopt the more aggressive 50 basis point policy easing of alternative A but would not make an explicit assessment of the balance of risks and thus would provide no direct indication that the Committee was considering a further easing move. As noted in the Bluebook, adoption of alternative B would be consistent with the 50 basis point downward revision to the Greenbook-consistent measure of r*. Policy easing of roughly that magnitude over the next several quarters would also be consistent with the optimal policy calculations under a 2 percent inflation rule as well as with a number of the policy rules presented in the Bluebook. Even if you are not sure that the adverse effects on aggregate demand of ongoing financial developments will be as severe as built into the Greenbook baseline, you may be concerned enough to judge that a 50 basis point easing of policy today would provide a measure of insurance that could prove valuable if, as seems likely at a minimum, further financial aftershocks become evident. As I noted, the risk assessment proposed for alternative B is relatively open-ended. The current version suggests being explicit that uncertainty about the economic outlook has increased; for that reason, it does not provide an explicit risk assessment. You may believe, given considerable uncertainty about the implications of financial developments to date and their likely course going forward, that characterizing the balance of risks would be quite difficult and may lack credibility. For the same reasons, you may find appealing the noncommittal approach of this alternative regarding future rate actions. As Bill Dudley noted, market expectations for the path of monetary policy have fallen sharply over the intermeeting period. At the moment, market participants seem to put substantial odds on both a 25 basis point and a 50 basis point easing today— although, given the modest improvement in credit markets over the past few days, the former is now seen as somewhat more likely. Short-term rates would likely drop a little under alternative B and more sharply under A, whereas they might move up a little under C. Longer-term yields could decline noticeably under alternative A if the statement and the action prompted greater concern among market participants about the outlook. The inconclusive risk assessment of alternative B would likely surprise market participants and might prompt some volatility as they attempted to discern your message. But all things considered, the rate actions and the statements associated with alternatives B and C do not seem sharply at odds with expectations, and we would not expect large net market reactions." FinancialCrisisReport--29 Credit ratings are issued by private firms that have been officially designated by the SEC as Nationally Recognized Statistical Rating Organizations (NRSROs). NRSROs are usually referred to as “credit rating agencies.” While there are ten registered credit rating agencies in the United States, the market is dominated by just three: Moody’s Investors Service, Inc. (Moody’s); Standard & Poor’s Financial Services LLC (S&P); and Fitch Ratings Ltd. (Fitch). 38 By some accounts, these firms issue about 98% of the total credit ratings and collect 90% of total credit rating revenue in the United States. 39 Credit ratings use a scale of letter grades to indicate credit risk, ranging from AAA to D, with AAA ratings designating the safest investments. Investments with AAA ratings have historically had low default rates. For example, S&P reported that its cumulative RMBS default rate by original rating class (through September 15, 2007) was 0.04% for AAA initial ratings and 1.09% for BBB. 40 Financial instruments bearing AAA through BBB- ratings are generally referred to as “investment grade,” while those with ratings below BBB- (or Baa3) are referred to as “below investment grade” or sometimes as having “junk” status. Financial instruments that default receive a D rating from Standard & Poor’s, but no rating at all from Moody’s. Investors often rely on credit ratings to gauge the safety of a particular investment. Some institutional investors design an investment strategy that calls for acquiring assets with specified credit ratings. State and federal law also restricts the amount of below investment grade bonds that certain investors can hold, such as pension funds and insurance companies. 41 Banks are also limited by law in the amount of noninvestment grade bonds they can hold, and are typically required to post additional capital for investments carrying riskier ratings. Because so many federal and state statutes and regulations required financial institutions to hold securities with investment grade ratings, the credit rating agencies were not only guaranteed a steady business, but were encouraged to issue AAA and other investment grade ratings. Issuers of securities and other financial instruments also worked hard to obtain favorable credit ratings to ensure more investors could buy their products. Although the SEC has generally overseen the credit rating industry for many years, it had no statutory basis to exercise regulatory authority until enactment of the Credit Rating Agency Reform Act in September 2006. Concerned by the inflated credit ratings that had been issued for 37 See 9/3/2009 “Credit Rating Agencies and Their Regulation,” prepared by the Congressional Research Service Report No. R40613 (revised report issued 4/9/2010). For more information about the credit rating process and the credit rating agencies, see Chapter V, below. 38 See 9/25/2008 “Credit Rating Agencies—NRSROs,” SEC, http://www.sec.gov/answers/nrsro.htm. 39 See 9/3/2009 “Credit Rating Agencies and Their Regulation,” prepared by the Congressional Research Service Report No. R40613 (revised report issued 4/9/2010). 40 Prepared Statement of Vickie A. Tillman, Executive Vice President, Standard & Poor’s Credit Market Services, “The Role of Credit Rating Agencies in the Structured Finance Market,” before the U.S. House of Representatives Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises of the Committee on Financial Services, Serial No. 110-62 (9/27/2007), S&P SEC-PSI 0001945-71, at 51. (See Chapter V below.) See also 1/2007 “Annual 2006 Global Corporate Default Study and Ratings Transitions,” S&P. 41 For more detail on these matters, see Chapter V, below. bonds from Enron Corporation and other troubled corporations, Congress strengthened the SEC’s authority over the credit rating industry. Among other provisions, the law established criteria for the NRSRO designation and authorized the SEC to conduct examinations of credit rating agencies. The law also, however, prohibited the SEC from regulating credit rating criteria or methodologies used in credit rating models. In June 2007, the SEC issued implementing regulations, which were essentially too late to affect the ratings already provided for mortgage related securities. One month later, in July 2007, the credit rating agencies issued the first of several mass downgrades of the ratings earlier issued for mortgage related securities. CHRG-110shrg50420--70 Mr. Dodaro," The billion-and-a-half from all were conditions. But my point is is that the board wasn't engaged in the managing of the companies. The board was engaged in financing, and to a, you could say to a good extent, restructuring the companies. Senator Crapo. And we wouldn't be suggesting anything any different than that sort of arrangement now. Thank you very much. " FOMC20050630meeting--419 417,MS. DANKER.," I’ll be reading the directive from page 30 of the Bluebook and the balance of risk assessment from the draft statement: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 3¼ percent.” And for the statement: “The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”" CHRG-111shrg62643--186 PREPARED STATEMENT OF BEN S. BERNANKE Chairman, Board of Governors of the Federal Reserve System July 21, 2010 Chairman Dodd, Senator Shelby, and Members of the Committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress.Economic and Financial Developments The economic expansion that began in the middle of last year is proceeding at a moderate pace, supported by stimulative monetary and fiscal policies. Although fiscal policy and inventory restocking will likely be providing less impetus to the recovery than they have in recent quarters, rising demand from households and businesses should help sustain growth. In particular, real consumer spending appears to have expanded at about a 2\1/2\ percent annual rate in the first half of this year, with purchases of durable goods increasing especially rapidly. However, the housing market remains weak, with the overhang of vacant or foreclosed houses weighing on home prices and construction. An important drag on household spending is the slow recovery in the labor market and the attendant uncertainty about job prospects. After 2 years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, a pace insufficient to reduce the unemployment rate materially. In all likelihood, a significant amount of time will be required to restore the nearly 8\1/2\ million jobs that were lost over 2008 and 2009. Moreover, nearly half of the unemployed have been out of work for longer than 6 months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers' employment and earnings prospects. In the business sector, investment in equipment and software appears to have increased rapidly in the first half of the year, in part reflecting capital outlays that had been deferred during the downturn and the need of many businesses to replace aging equipment. In contrast, spending on nonresidential structures--weighed down by high vacancy rates and tight credit--has continued to contract, though some indicators suggest that the rate of decline may be slowing. Both U.S. exports and U.S. imports have been expanding, reflecting growth in the global economy and the recovery of world trade. Stronger exports have in turn helped foster growth in the U.S. manufacturing sector. Inflation has remained low. The price index for personal consumption expenditures appears to have risen at an annual rate of less than 1 percent in the first half of the year. Although overall inflation has fluctuated, partly reflecting changes in energy prices, by a number of measures underlying inflation has trended down over the past 2 years. The slack in labor and product markets has damped wage and price pressures, and rapid increases in productivity have further reduced producers' unit labor costs. My colleagues on the Federal Open Market Committee (FOMC) and I expect continued moderate growth, a gradual decline in the unemployment rate, and subdued inflation over the next several years. In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared forecasts of economic growth, unemployment, and inflation for the years 2010 through 2012 and over the longer run. The forecasts are qualitatively similar to those we released in February and May, although progress in reducing unemployment is now expected to be somewhat slower than we previously projected, and near-term inflation now looks likely to be a little lower. Most FOMC participants expect real GDP growth of 3 to 3\1/2\ percent in 2010, and roughly 3\1/2\ to 4\1/2\ percent in 2011 and 2012. The unemployment rate is expected to decline to between 7 and 7\1/2\ percent by the end of 2012. Most participants viewed uncertainty about the outlook for growth and unemployment as greater than normal, and the majority saw the risks to growth as weighted to the downside. Most participants projected that inflation will average only about 1 percent in 2010 and that it will remain low during 2011 and 2012, with the risks to the inflation outlook roughly balanced. One factor underlying the Committee's somewhat weaker outlook is that financial conditions--though much improved since the depth of the financial crisis--have become less supportive of economic growth in recent months. Notably, concerns about the ability of Greece and a number of other euro-area countries to manage their sizable budget deficits and high levels of public debt spurred a broad-based withdrawal from risk-taking in global financial markets in the spring, resulting in lower stock prices and wider risk spreads in the United States. In response to these fiscal pressures, European leaders put in place a number of strong measures, including an assistance package for Greece and =500 billion of funding to backstop the near-term financing needs of euro-area countries. To help ease strains in U.S. dollar funding markets, the Federal Reserve reestablished temporary dollar liquidity swap lines with the ECB and several other major central banks. To date, drawings under the swap lines have been limited, but we believe that the existence of these lines has increased confidence in dollar funding markets, helping to maintain credit availability in our own financial system. Like financial conditions generally, the state of the U.S. banking system has also improved significantly since the worst of the crisis. Loss rates on most types of loans seem to be peaking, and, in the aggregate, bank capital ratios have risen to new highs. However, many banks continue to have a large volume of troubled loans on their books, and bank lending standards remain tight. With credit demand weak and with banks writing down problem credits, bank loans outstanding have continued to contract. Small businesses, which depend importantly on bank credit, have been particularly hard hit. At the Federal Reserve, we have been working to facilitate the flow of funds to creditworthy small businesses. Along with the other supervisory agencies, we issued guidance to banks and examiners emphasizing that lenders should do all they can to meet the needs of creditworthy borrowers, including small businesses. \1\ We also have conducted extensive training programs for our bank examiners, with the message that lending to viable small businesses is good for the safety and soundness of our banking system as well as for our economy. We continue to seek feedback from both banks and potential borrowers about credit conditions. For example, over the past 6 months we have convened more than 40 meetings around the country of lenders, small business representatives, bank examiners, government officials, and other stakeholders to exchange ideas about the challenges faced by small businesses, particularly in obtaining credit. A capstone conference on addressing the credit needs of small businesses was held at the Board of Governors in Washington last week. \2\ This testimony includes an addendum that summarizes the findings of this effort and possible next steps.--------------------------------------------------------------------------- \1\ See Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision, and Conference of State Bank Supervisors (2010), ``Regulators Issue Statement on Lending to Creditworthy Small Businesses'', joint press release, February 5, www.federalreserve.gov/newsevents/press/bcreg/20100205a.htm. \2\ For more information, see Ben S. Bernanke (2010), ``Restoring the Flow of Credit to Small Businesses'', speech delivered at ``Addressing the Financing Needs of Small Businesses,'' a forum sponsored by the Federal Reserve Board, Washington, July 12, www.federalreserve.gov/newsevents/speech/bernanke20100712a.htm.---------------------------------------------------------------------------Federal Reserve Policy The Federal Reserve's response to the financial crisis and the recession has involved several components. First, in response to the periods of intense illiquidity and dysfunction in financial markets that characterized the crisis, the Federal Reserve undertook a range of measures and set up emergency programs designed to provide liquidity to financial institutions and markets in the form of fully secured, mostly short-term loans. Over time, these programs helped to stem the panic and to restore normal functioning in a number of key financial markets, supporting the flow of credit to the economy. As financial markets stabilized, the Federal Reserve shut down most of these programs during the first half of this year and took steps to normalize the terms on which it lends to depository institutions. The only such programs currently open to provide new liquidity are the recently reestablished dollar liquidity swap lines with major central banks that I noted earlier. Importantly, our broad-based programs achieved their intended purposes with no loss to taxpayers. All of the loans extended through the multiborrower facilities that have come due have been repaid in full, with interest. In addition, the Board does not expect the Federal Reserve to incur a net loss on any of the secured loans provided during the crisis to help prevent the disorderly failure of systemically significant financial institutions. A second major component of the Federal Reserve's response to the financial crisis and recession has involved both standard and less conventional forms of monetary policy. Over the course of the crisis, the FOMC aggressively reduced its target for the Federal funds rate to a range of 0 to \1/4\ percent, which has been maintained since the end of 2008. And, as indicated in the statement released after the June meeting, the FOMC continues to anticipate that economic conditions--including low rates of resource utilization, subdued inflation trends, and stable inflation expectations--are likely to warrant exceptionally low levels of the federal funds rate for an extended period. \3\--------------------------------------------------------------------------- \3\ See, Federal Reserve Board of Governors (2010), ``FOMC Statement'', press release, June 23, www.federalreserve.gov/newsevents/press/monetary/20100623a.htm.--------------------------------------------------------------------------- In addition to the very low Federal funds rate, the FOMC has provided monetary policy stimulus through large-scale purchases of longer-term Treasury debt, Federal agency debt, and agency mortgage-backed securities (MBS). A range of evidence suggests that these purchases helped improve conditions in mortgage markets and other private credit markets and put downward pressure on longer-term private borrowing rates and spreads. Compared with the period just before the financial crisis, the System's portfolio of domestic securities has increased from about $800 billion to $2 trillion and has shifted from consisting of 100 percent Treasury securities to having almost two-thirds of its investments in agency-related securities. In addition, the average maturity of the Treasury portfolio nearly doubled, from 3\1/2\ years to almost 7 years. The FOMC plans to return the System's portfolio to a more normal size and composition over the longer term, and the Committee has been discussing alternative approaches to accomplish that objective. One approach is for the Committee to adjust its reinvestment policy--that is, its policy for handling repayments of principal on the securities--to gradually normalize the portfolio over time. Currently, repayments of principal from agency debt and MBS are not being reinvested, allowing the holdings of those securities to run off as the repayments are received. By contrast, the proceeds from maturing Treasury securities are being reinvested in new issues of Treasury securities with similar maturities. At some point, the Committee may want to shift its reinvestment of the proceeds from maturing Treasury securities to shorter-term issues, so as to gradually reduce the average maturity of our Treasury holdings toward precrisis levels, while leaving the aggregate value of those holdings unchanged. At this juncture, however, no decision to change reinvestment policy has been made. A second way to normalize the size and composition of the Federal Reserve's securities portfolio would be to sell some holdings of agency debt and MBS. Selling agency securities, rather than simply letting them run off, would shrink the portfolio and return it to a composition of all Treasury securities more quickly. FOMC participants broadly agree that sales of agency-related securities should eventually be used as part of the strategy to normalize the portfolio. Such sales will be implemented in accordance with a framework communicated well in advance and will be conducted at a gradual pace. Because changes in the size and composition of the portfolio could affect financial conditions, however, any decisions regarding the commencement or pace of asset sales will be made in light of the Committee's evaluation of the outlook for employment and inflation. As I noted earlier, the FOMC continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the Federal funds rate for an extended period. At some point, however, the Committee will need to begin to remove monetary policy accommodation to prevent the buildup of inflationary pressures. When that time comes, the Federal Reserve will act to increase short-term interest rates by raising the interest rate it pays on reserve balances that depository institutions hold at Federal Reserve Banks. To tighten the linkage between the interest rate paid on reserves and other short-term market interest rates, the Federal Reserve may also drain reserves from the banking system. Two tools for draining reserves from the system are being developed and tested and will be ready when needed. First, the Federal Reserve is putting in place the capacity to conduct large reverse repurchase agreements with an expanded set of counterparties. Second, the Federal Reserve has tested a term deposit facility, under which instruments similar to the certificates of deposit that banks offer their customers will be auctioned to depository institutions. Of course, even as the Federal Reserve continues prudent planning for the ultimate withdrawal of extraordinary monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain. We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our Nation's productive potential in a context of price stability.Financial Reform Legislation Last week, the Congress passed landmark legislation to reform the financial system and financial regulation, and the President signed the bill into law this morning. That legislation represents significant progress toward reducing the likelihood of future financial crises and strengthening the capacity of financial regulators to respond to risks that may emerge. Importantly, the legislation encourages an approach to supervision designed to foster the stability of the financial system as a whole as well as the safety and soundness of individual institutions. Within the Federal Reserve, we have already taken steps to strengthen our analysis and supervision of the financial system and systemically important financial firms in ways consistent with the new legislation. In particular, making full use of the Federal Reserve's broad expertise in economics, financial markets, payment systems, and bank supervision, we have significantly changed our supervisory framework to improve our consolidated supervision of large, complex bank holding companies, and we are enhancing the tools we use to monitor the financial sector and to identify potential systemic risks. In addition, the briefings prepared for meetings of the FOMC are now providing increased coverage and analysis of potential risks to the financial system, thus supporting the Federal Reserve's ability to make effective monetary policy and to enhance financial stability. Much work remains to be done, both to implement through regulation the extensive provisions of the new legislation and to develop the macroprudential approach called for by the Congress. However, I believe that the legislation, together with stronger regulatory standards for bank capital and liquidity now being developed, will place our financial system on a sounder foundation and minimize the risk of a repetition of the devastating events of the past 3 years. Thank you. I would be pleased to respond to your questions. FOMC20050809meeting--218 216,MS. DANKER.," I’ll be reading the directive and the risk assessment from page 23 of the Bluebook: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 3½ percent.” The risk assessment portion reads: “The Committee perceives that with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill August 9, 2005 94 of 110" FOMC20080310confcall--71 69,MR. ROSENGREN.," Market conditions have deteriorated and are likely getting worse. I strongly support both the swap and the TSLF to help mitigate those problems. In the longer run, I think we do need to consider how to better assess counterparty risk to primary dealers. Thank you, Mr. Chairman. " CHRG-111shrg54675--92 RESPONSE TO WRITTEN QUESTIONS OF SENATOR KOHL FROM FRANK MICHAELQ.1. I have heard from many small businesses struggling to find lines of credit and keep their doors open. How has the member business lending cap affected the ability of credit unions to make small business loans to their members? Does your organization have any data showing that more small businesses would be served if the member business lending cap was increased by loan size and volume? In the current credit crisis, do you believe that credit unions are able to provide more loans to small businesses and should the cap be raised?A.1. The member business lending cap has affected the ability of credit unions to make small business loans to their members in two ways. First, many of the roughly one quarter of credit unions that offer business loans are getting sufficiently close to the cap for it to affect their behavior. Long before a credit union actually reaches the arbitrary 12.25 percent cap it must begin to moderate its business lending in order to stay below the cap. Considering the vast majority of credit unions that were not originally grandfathered from the cap, fully 38 percent of credit union business loans outstanding are in credit unions with more than 10 percent of assets in business loans. That means that almost 40 percent of the market is essentially frozen. Another 21 percent of the business loans outstanding in credit unions that are not grandfathered is in credit unions with business loans between 7.5 percent and 10 percent of assets. These credit unions are approaching the territory at which they will need to moderate business lending growth. A total of almost 60 percent of nongrandfathered credit union business loans is in credit unions at or near the cap. Second, the cap not only restricts the credit unions that are engaging in business lending and approaching their limit, but also discourages credit unions who would like to enter the business lending market. The cap effectively limits entry into the business lending arena on the part of small- and medium-sized credit unions--the vast majority of all credit unions--because the startup costs and requirements, including the need to hire and retain staff with business lending experience, exceed the ability of many credit unions with small portfolios to cover these costs. Today, only one in four credit unions have MBL programs and aggregate credit union member business loans represent only a fraction of the commercial loan market. Eliminating or expanding the limit on credit union member business lending would allow more credit unions to generate the level of income needed to support compliance with NCUA's regulatory requirements and would expand business lending access to many credit union members, thus helping local communities and the economy. CUNA has produced an estimate of how much additional business lending could be provided by credit unions if the cap were raised to 25 percent of assets. We assume that all current business lending credit unions will hold business loans in the same proportion to the new cap that they currently do to the existing cap, and that they will use one half of the new authority in the first year. Further, we assume that on average credit unions that currently make no business loans will as a group add business loans equal to 1 percent of their assets. Applying these assumptions to second quarter NCUA Call Report data indicates an additional $12.5 billion in business loans for America's small businesses. Based on this analysis, we conservatively project that credit unions could provide up to an additional $10 billion of business loans in the first year after the raising of the cap. ------ CHRG-111hhrg56241--85 Mr. Bebchuk," I think I would share your general sentiments that taxpayers have not charged financial firms sufficiently to make up for the substantial level of support that has been extended over the last year. And, more generally, I think that we can think about the pie that is being produced by the financial sector as being a result of contributions by taxpayers, by shareholders who provide capital, and by financial executives. And until now, the taxpayers have not been charging enough and shareholder interests have not been sufficiently protected. And the ultimate result of that is that financial executives--and AIG would be just one example, but more generally the sector--the financial executives might be getting an excessive fraction of this pie. Mr. Moore of Kansas. Ms. Minow, do you have any thoughts? Ms. Minow. Yes, I do. In the future, I hope we never have to do another bailout, but if we do, I hope we impose some conditions before we turn over the money. And condition number one should be that you take a discount on any incentive compensation for the amount that was subsidized. Mr. Moore of Kansas. Thank you. Mr. Stiglitz? " FOMC20061025meeting--266 264,MR. MISHKIN.," If it were a textbook, and I can tell you I know a lot about this, you wouldn’t sell one copy. [Laughter] So it’s a problem. We see this in practice in that the markets pay very little attention to the Monetary Policy Report. A feature of inflation-targeting regimes is that they produce something called inflation reports. (By the way, I would never want to call it that in the United States; I would want to stick with Monetary Policy Report—it is a good name, and it fits into this evolutionary view.) They have improved the quality of these documents so that they receive a lot of attention. Those reports have become extremely important vehicles for getting the central bank’s views across to the public and for helping the public understand what the central banks are doing; they actually also provide support for the central bank to pursue optimal policy. So improving these documents would have tremendous benefits, and I think it could be done, and I actually think the staff would probably enjoy doing them—well, maybe not. [Laughter] You’d be working harder, but that’s why you get paid the big bucks. I think you’d actually enjoy doing this. In the inflation reports, they’ve moved to using the best textbook writing techniques—nice colors, boxes. Ben and I have been involved in this process. It’s the reason that I can afford my spouse. It’s a change in the nature of the way this is done, but I think it’s very doable and will have a lot of benefits. The last box in the decision tree is technical issues. That’s not what we’re here to discuss today. There are a lot of them. How should we report the participants’ forecasts, if we go that route? What price index should we use? We would have to agree at least on what price index and whether it is a core or a headline measure before providing our views about what price stability means. Would it be a point or a range? What should be the form of the Monetary Policy Report document? Also, what does economic analysis tell us about the optimal level of long-run inflation rates so that we can actually think about the sense of it? Even though I’ve written a lot about this, I would like to think about all of it from scratch, and I would encourage the Committee to do that as well. In that regard, I would like to have the staff do even more work. The staff would need to provide us with a set of documents to get us to rethink these issues. There are a lot of technical issues. The documents that you provided for the January 2005 meeting were excellent. But I would basically have a complete relook because I think there are some changes that we should be aware of, and then we can decide on what index. Some of us may change our views on exactly what number we think is the right number for the long-run inflation goal. If we go this route, we might try a dry run on some of these things because of what Governor Kohn mentioned—once you go this route, it’s not easy to go back; so you had better get it right. We might want to try dry runs of what procedure we would use to provide information. If we have a Monetary Policy Report document, we might try dry runs that we would actually discuss in this Committee. I think by doing that we would be more likely to get it right. Anyway, I am sorry to have gone on so long. I have now made up for the fact that I have been quieter other times, and I’ll try to be quiet in the future if I can. Thank you very much." FOMC20081216meeting--104 102,MR. COVITZ.," 3 Thank you. I will be using the packet of charts that starts with the staff presentation on financial markets. The charts for the other two presentations are included in this packet and follow mine. As shown in the top left panel of your first exhibit, long-term nominal Treasury yields posted their largest intermeeting decline in over twenty years. The primary explanation for this decline, outlined to the right, is that investors markedly revised down their economic outlook, leading both to a lower expected path of monetary policy and to continued flight to high-quality assets and away from securities with credit and liquidity risk. Yields also fell following Fed communications regarding alternative monetary policy tools, such as the purchase of long-term Treasury securities, agency debt, and mortgage-backed securities. One measure of flight to quality, shown in the middle left panel, is the covariance of percent changes in stock prices and Treasury yields. When investors pull back from risk-taking, stock prices fall, and so do Treasury yields, resulting in a positive covariance between the two. When flight-to-quality effects are substantial, prices in both markets are volatile, making the covariance particularly large. In recent months, the covariance soared to well beyond its 2002 peak. Since the October FOMC, it has come down somewhat but remains extremely elevated, an indication of continued and substantial flight to quality. Another perspective on investor perceptions is provided by the equity risk premium, shown by the red shaded region in the panel to the right and measured as the difference between a trend year-ahead earnings-to-price ratio on S&P 500 stocks and a real long-run Treasury yield. This measure ballooned in midNovember as stock prices and Treasury yields fell and then narrowed a bit over the past month, as indicated by the plus signs. Even so, the risk premium remains extraordinarily wide. Yield spreads on 10-year corporate bonds, shown in the bottom left panel, increased further over the intermeeting period. The spread on high-yield bonds (the red line) topped 1,600 basis points, and the spread on BBB-rated bonds (the black line) exceeded 600 basis points. The BBB spread is now comparable to average levels recorded on similarly rated bonds during the Great Depression. Changes in corporate bond spreads can be decomposed into changes in one-year forward spreads. As shown in the panel to the right, the 117 basis point intermeeting increase in the 10year BBB spread reflects increases in forward spreads across the term structure, consistent with investor flight to quality and away from risk. In addition, the forward spreads ending in two years and five years increased more than the spread ending in 10 years, suggesting that investors have become more concerned about credit risk in 3 The materials used by Mr. Covitz, Ms. Aaronson, and Mr. Ahmed are attached to this transcript (appendix 3). the medium term--that is, more concerned about the possibility of a protracted economic downturn. Your next exhibit examines recent conditions in the commercial paper market. As shown in the top left panel, outstanding financial CP and ABCP (the black and red lines) dropped in September and October but since then have partially rebounded. In contrast, nonfinancial commercial paper outstanding (the blue line) has been relatively flat, although nonfinancial programs rated A2/P2 (not shown) have contracted roughly 40 percent since early September. The noticeable increases in financial CP and ABCP around the time of the last FOMC meeting reflect the implementation of the Federal Reserve's commercial paper funding facility (CPFF), which ramped up quickly and now holds roughly $300 billion of highly rated commercial paper. The recent stability is also likely due to flows back into prime money market funds since early November (shown by the red bars above the zero line in the panel to the right). According to recent surveys of money-fund managers, prime funds have substantially increased their holdings of ABCP, reportedly reflecting the confidence provided by the asset-backed commercial paper money market mutual fund liquidity facility (AMLF), which stands ready to provide banking organizations with nonrecourse loans to fund purchases of highly rated ABCP from 2a-7 money funds. Turning to pricing, the middle left panel shows that the spread on overnight A2/P2-rated nonfinancial CP (the blue line) trended down over the intermeeting period. About half of the reduction in A2/P2 spreads reflects a sample shift toward higher quality overnight issuers, while the other half of the spread reduction is due to improvements in pricing for a constant sample of issuers, suggesting a positive spillover from sectors of the market directly affected by the Fed liquidity programs. The overnight ABCP spread (the red line) also declined, on net, over the intermeeting period. In contrast, overnight yields on CP from highly rated nonfinancial and financial programs (not shown) have traded at levels close to the effective federal funds rate for the past several weeks. To examine year-end pressures, the panel to the right shows the gap between thirty-day and overnight A2/P2 yields. This gap has been volatile but has trended up since late November, when the 30-day rate from our smoothed yield curve began to reflect trades that crossed year-end. Year-end funding pressures are explored further in the bottom left panel. The red bars show average percentages of paper that were placed over year-end as of mid-December from 2003 to 2007. The corresponding percentages for 2008 are denoted in blue. The first two bars indicate that, with respect to getting past year-end, programs rated above A2/P2 as a group are ahead of their average pace over the previous five years. In contrast, the second two bars show that lower-rated programs are behind. Overall, as outlined in the bullet points to the right, conditions in the commercial paper market appear to have been stabilized by the various policy interventions in this market. Even conditions in the nonfinancial A2/P2 sector, which falls outside the government liquidity and guarantee programs, have improved, but the sector remains strained. Year-end pressures appear substantial for lower-rated programs. The remainder of my briefing reviews funding flows in longer-term markets, starting with financing for nonfinancial businesses. As shown by the red portions of the bars in the top left panel of exhibit 3, investment-grade bond issuance has held up fairly well in recent months, while speculative-grade issuance, shown by the blue portions of the bars, has dwindled to nothing. This pace of financing does not appear to pose substantial near-term funding pressures for the nonfinancial corporate sector as a whole. As shown by the blue bars to the right, the volume of speculative-grade bonds due to mature is relatively light in 2009 and 2010 before it moves up somewhat in 2011. Moreover, the pace of investment-grade bonds that will mature in coming years, denoted by the red bars, is comparable to recent issuance levels. In addition, as shown in the middle left panel, liquid asset ratios for firms rated speculative- and investment-grade remain relatively high. Perhaps more troubling for nonfinancial businesses is that funding from banks has slowed. As shown in the middle right panel, C&I loans expanded rapidly in September and October reportedly reflecting, to a substantial extent, a wave of drawdowns on existing lines of credit. However, the expansion of C&I loans halted in November. Equally striking, the plot in the bottom left panel shows that the change in commercial mortgage debt, based on flow of funds data, turned substantially negative in the third quarter, as the outstanding amounts both at banks and in securitizations fell. Overall, nonfinancial business borrowing, shown on the bottom right, has slowed sharply this year, and with financial conditions expected to remain tight and investment projected to be weak, the staff forecast calls for borrowing to remain very tepid through at least 2010. Household credit is the subject of my final exhibit. Mortgage debt, shown by the blue line in the top left panel, is estimated to have contracted in the second and third quarters, in combination with the continued decline in house prices, shown by the thin black line. We have very little data for mortgage debt in the fourth quarter, but MBS issuance in October, shown to the right, was somewhat below the already low thirdquarter level. Other types of household debt have also begun to contract. As shown in the middle left panel, revolving and nonrevolving consumer credit rose only a bit in the third quarter and then fell in October. While the slowdown in consumer credit likely reflects, in part, a reduction in demand, the secondary market for such credit has also become substantially impaired. As shown to the right, issuance of ABS backed by auto and credit card loans slowed markedly in the third quarter and was near zero in October and November, as quoted spreads on BBB and AAA ABS (not shown) soared. Results from the Michigan survey, shown in the bottom left panel, suggest that the contraction in household debt reflects both the reduced supply of credit and weak demand. As shown by the black line, an unprecedented share of households has pointed in recent months to tighter credit as the reason that it has not been a good time to purchase an automobile. At the same time, the percentage citing concerns about the economy, plotted in red, has increased to the top of its historical range and remains the reason mentioned most often by respondents as a deterrent to purchasing an automobile. With financial markets under stress, consumer credit likely will need to be funded mainly on bank balance sheets in coming quarters. However, as shown in the panel to the right, banks' unused loan commitments for both households and businesses have declined substantially this year, as net new commitments have not kept up with drawdowns on existing lines--another indication of the tighter supply of bank credit. Stephanie will now continue with our presentation. " FOMC20050920meeting--141 139,MS. DANKER.," I’ll be reading the directive wording from page 27 of the Bluebook and the assessment of risk from exhibit 6 in the material that was passed out. For the directive: “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 3¾ percent.” Now for the assessment of risk: “The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to September 20, 2005 104 of 117 is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”" FOMC20060131meeting--167 165,MS. DANKER.," Thank you, Mr. Chairman. In that the decision has been to go ahead with the status quo in the same way as in the past, I will read the wording out of page 31 of the Bluebook—the directive wording first and the risk assessment second, dropping the word “well.” “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 4½ percent.” And “The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.” Chairman Greenspan Yes Vice Chairman Geithner Yes Governor Bies Yes Governor Ferguson Yes President Guynn Yes Governor Kohn Yes President Lacker Yes Governor Olson Yes President Pianalto Yes President Yellen Yes" CHRG-111hhrg58044--288 Mr. Wilson," It is on the credit report. It is not used in scoring. " CHRG-109hhrg31539--88 Mr. Baker," Let me jump in before my yellow turns red. I met Mr. Olsen yesterday, and had a great conversation about these general parameters. The last piece of this, I believe, is that the most insidious force in market function were CEO's and CFO's trying to beat the street every 90 days with manipulation of the rules to exceed market expectation. Do you support, as I do, and I believe others have expressed, including the Chamber, encouraging companies to move away from the 90-day reporting, and would that in a way deter investors' abilities to make proper judgments about economic condition of corporations? " FOMC20081216meeting--315 313,MR. HOENIG.," If we're going to have statements that say we're going to purchase mortgage-backed securities as conditions warrant, I don't think ""purchasing longer-term Treasury securities"" is a much different step from that, so we can leave it in. " CHRG-111hhrg55809--104 Mr. Bernanke," I don't know how much effect it would have. That would require more study. I think it is the same tradeoff, though. You can make the conditions tougher and tougher, and that reduces the risk to the taxpayer, absolutely, but it also reduces the number of people who can get mortgages. " CHRG-111hhrg48873--383 Secretary Geithner," Well, it depends on whether they meet the broad conditions we are going to establish to try to protect the American taxpayer. Again, we want to make sure that the investors and the asset managers meet the highest standards for care and competence. " FinancialCrisisReport--576 Failure to Liquidate. In July 2007, after the credit rating agencies began the mass downgrades of RMBS securities, the first RMBS securities underlying the Hudson CDO lost their investment grade ratings, and the CDS contracts referencing those assets qualified as Credit Risk Assets requiring liquidation. 2581 Within three months, by October 15, 2007, over 28% of the Hudson assets qualified as Credit Risk Assets. 2582 As liquidation agent, Goldman should have begun issuing bids to sell the assets at the best possible price and remove them from the Hudson CDO, but it did not. In October 2007, Goldman began to contact Hudson investors to discuss transferring its liquidation agent responsibilities to a third party. That transfer required investor consent. Benjamin Case took notes of two telephone conversations he had with a Hudson investor, National Australia Bank (NAB), discussing the issues. 2583 In the calls, Mr. Case explained why Goldman had yet to liquidate any of the Credit Risk Assets, explaining that Goldman was waiting for asset prices to improve. 2584 He also reported that Goldman was considering an amendment to the Hudson transaction that would extend the maximum liquidation period, as well as make other structural changes to the Hudson deal. 2585 According to his notes, Mr. Case informed NAB that Goldman was seeking to transfer its liquidation role to a third party with more liquidation experience, because that change: “will be in the best interest of investors – the credit obligation term was originally written with the expectation that was unlikely to happen. ... Good for several reasons: 1. Large institutional assets manager will be able to access more liquidity b/c [because] they can access other broker dealers and get good pricing[.] 2580 Id. Mr. Herrick was not employed by Goldman when its CDO assets were downgraded and triggered its liquidation agent duties. 2581 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-021880171 (attached file, “Deal Summary,” GS MBS-E-021880172). 2582 2583 Id. 10/15/2007 email from Naina Kalavar, “NAB/Hudson Mezz Update 2,” GS MBS-E-015738973. Mr. Case used this email to circulate his notes of the two telephone conversations. 2584 Id. at 2. The notes included the following: “[C]urrent distressed nature of the assets has been fully priced in and has not moved over the past 2 months – if unwound those cds would be at 80-90 points, that is % points to be paid up front to unwind swap – equiv of 20 cents to dollar in cash bond terms ... Across entire universe of loans already in liquidation – been generally se[e]n 50-60-70 % recovery rates. Rates are not coming back high enough to make the market opt[i]mistic that bonds will come back to recover princi[pal]. ... Our view that there is upside in waiting an[d] evaluating mtkt conditions before liquidating. ... W e think that the shorts may get impatient – minor rallies from short covering – domino effect/momentum creates a rally b/c shorts get nervous at little rally – this provides potential upside to waiting to liquidate. ” 2585 Id. at 3. Such an amendment would require investor consent. 2. Even keeping the deal the way it is, the decision of when in the 12 month period to liquidate could be better handled by an experienced manager[.] 3. Potential amendment could be made to benefit the deal by giving more flexibility to agent.” 2586 FOMC20080805meeting--155 153,MR. HOENIG.," Thank you, Mr. Chairman. I appreciate the fact that reasonable people may differ, and I do differ. In saying that, I am not advocating a tight monetary policy. I am advocating a less accommodative monetary policy. I recognize Governor Kohn's point that relative prices are adjusting, and others have made that point. I think around that context is the fact that we are seeing a systematic increase in the price indexes, both total and core, and I don't think we should ignore that. Now, the core is creeping up, but up nevertheless, and it is systematic in my view. I would feel more comfortable that it was transitory if policy were not so accommodative, which affirms the likelihood of further increases in inflation going forward. That is really where I am focused, I guess is the way to say it. We introduced the policy that we have, as I think others mentioned, as an insurance policy early on, when we were more in an immediate crisis. I don't negate or minimize the tension that we are under, but I do think we have become very accommodative in our policy with negative real rates. So here we are with this insurance. We have this subpar growth. The subpar growth is not going to go away soon, so we are delaying removing the insurance policy. I worry about that. I think in the long run that does increase the risk of an inflationary problem of a sizable magnitude later on. I know we have this immediate problem, but our role also is to take a long-run view, and I think we would be wise to raise the rate now modestly. It would still be an easy policy. The effects of that increase might be disturbing to the markets. On the other hand, it might actually give more confidence to the markets that inflation is going to come down because we are going to insist that it does. I think there would be some good effects from that. So that is where I am coming from on preferring that we move rates up slightly at this point. Thank you. " FOMC20071211meeting--109 107,VICE CHAIRMAN GEITHNER.," Thank you. The outlook for real activity has deteriorated somewhat since our last meeting. In our modal forecast we now expect several quarters of growth below potential with real GDP for ’08 a bit above 2 percent. The sources of the deterioration in the outlook for us are pretty much as outlined in the Greenbook. What separates us from the Greenbook still is about 40 or 50 basis points of different views on what potential growth is. Our view of the likely path of the output gap is similar. So as in the Greenbook, we expect a deeper contraction in housing activity and prices. We expect nominal and real income growth to slow more than we expected and consumer spending also to moderate more than we had anticipated. Part of that lower path of real spending is, of course, due to energy prices. We also expect the rate of growth in business fixed investment to slow a bit more than we had previously thought, and these changes are in part, but not solely, due to the expected effects of tighter financial conditions. For a given path of the nominal fed funds rate, they are tighter now than they otherwise would have been because of the fall in the estimated neutral rate. In our view, growth in the rest of the world will slow a bit, but along with the effects of the decline in the dollar, it will still provide enough pull for net exports to contribute positively to growth, offsetting part of, but just part of, the deceleration in domestic demand growth. Our forecast for core inflation is little changed. We expect the core PCE deflator to rise at a rate just under 2 percent over the forecast period. Like many of you, we see considerable downside risks to the forecast for growth, and they have intensified since our last meeting. The Greenbook alternative scenarios on housing and the credit crunch seem plausible, perhaps more likely to happen together than to happen independently, and I think reality is likely to fall somewhere between the baseline Greenbook scenario and these two darker alternatives. The risk to the inflation forecast still seems closer to balance in the forecast period. The higher forward curve of energy prices and the lower path of the dollar will raise headline inflation a bit and, in the near term, the core inflation path. But these pressures should be offset by the fall in anticipated pressure on resource utilization, not just here but also globally where the economies that have been growing above potential are likely to slow as monetary policy tightens. I think it’s important to recognize that breakevens in inflation at longer horizons have stayed relatively stable in the context of the fairly substantial move in the dollar, the fairly substantial move in actual and expected energy and commodity prices, and the very dramatic change in expectations of how the Fed is likely to respond to the change in the balance of risks to growth. In light of these changes to the outlook and the risks to the outlook, we’ve lowered our expected path for the fed funds rate. We now think it’s likely that the Committee will reduce the target rate to 3.75 percent over the next few quarters, and this puts our real and our nominal fed funds rate assumption for ’08 a bit under the new path in the Greenbook. We’d raise it back in ’09. But our fed funds rate path is significantly above the market’s estimate. As you’ve all recognized, conditions in markets have deteriorated substantially since our last meeting, but the basic dynamic is still the same. Actual and anticipated losses to financial institutions have risen as the prices of a large range of assets have fallen. Uncertainty over the path of housing prices in the real economy and complexity in valuing assets and structured financial instruments that are most exposed to those risks make it very hard for markets to know with confidence the likely dimension of total losses and who is most exposed to them. Financial institutions have seen a sharp increase in their cost of funds, a substantial shortening in maturities at which they borrow, and a significant reduction in their ability to liquidate or borrow against their assets. Most banks have seen a very large and unanticipated expansion of their balance sheets as they’ve been forced or have chosen to provide funding in various forms. As banks and other financial institutions have moved to position themselves to deal with a more adverse economic and financial environment, they have become much more selective in how they use their liquidity and capital. The consequence of those actions is evident in the sharp increase in the cost of unsecured borrowing and the spreads on secured financing. Now, it’s important to recognize that, although a source of this pressure is concern about macroeconomic risk and its consequence for credit loss and asset values, the consequences of the adjustment by institutions to this new reality are very severe liquidity pressures in markets. These are particularly acute in Europe, and they are—at least in the market’s expectations—likely to persist well beyond year-end. These pressures are the symptom of the underlying problem, as fever is the sign of the immune system’s response to an infection. But just as high fevers can cause organ failure before the infection kills the body, illiquidity itself can threaten market functioning and the economy. The longer we live with these conditions—large spikes in demand for liquid risk-free assets, a general shortening of funding maturities, a limited amount of available financing even against high-quality collateral, the risk of substantial liquidation of financial assets, and the chances of runs on individual institutions’ funds—the more we are vulnerable to a self-reinforcing adverse spiral that leads to a greater retrenchment in credit supply than fundamentals might otherwise suggest and with a greater effect on growth. I don’t think the past four to six months have been kind to those who have argued that this was just a mild and transitory bump. As in August, I think we have to be willing to treat both the fever and the infection and, if you step back a second, the appropriate policy response to this set of challenges will entail a mix of measures. Monetary policy will probably have to be eased further to contain the risk of a more substantial and prolonged contraction in demand growth. I think we will probably need to continue to adjust our various liquidity instruments. We may need to encourage some institutions to raise more equity sooner than they otherwise might choose to do. We need to be very careful to avoid making both types of the classic errors in supervision in financial crises. These are, on the one hand, actions that would amplify the credit crunch by forcing banks to protect their ratios by selling more assets à la New England or, on the other hand, the commission of what you might call irresponsible forbearance à la Japan in the hopes of masking weakness and stretching out the pain. We also need to be careful to keep thinking through more adverse scenarios for the economy and the financial system and the policy responses that may be appropriate if they materialize. The United States is, I think, a remarkably resilient economy still. Outside of housing, we don’t have the same imbalance in inventories with the same degree of overinvestment in other parts of the economy that we have had going into past downturns. Corporate balance sheets still seem relatively healthy. The world economy is no doubt stronger. Current account imbalance is coming down. Our core institutions entered this adjustment period with a fair amount of capital. It is very encouraging to see so many of them start to raise capital so early. The financial infrastructure is more robust. Inflation expectations imply a fair degree of confidence in our ability to keep inflation low over time. The speed and the extent of the adjustment that we’ve seen in housing and by financial institutions to this new reality are really signs of health, of how well our system works. But we need to be cognizant that the market is torn between two quite plausible scenarios. In one, we just grow below potential for a given period of time as credit conditions adjust to this new equilibrium; in the other, we have a deep and protracted recession driven as much by financial headwinds as by other fundamentals. There are good arguments for the former, the more benign scenario, but we need to set policy in a way that reduces the probability of the latter, the more adverse scenario. Thank you." FOMC20060131meeting--112 110,MR. OLSON.," Thank you, Mr. Chairman. The surprise of the fourth-quarter GDP number and the slightly elevated inflationary pressure have caused us to take, I think, a closer look at the underlying strength of the economy. And to an extent it is reassuring—certainly, the strength in industrial production and real personal consumption. However, the risks that we have seen before remain and may, in fact, be slightly elevated. The potential risk of increased oil costs and the pass- through effect into underlying core inflation is at least slightly heightened, and with the flattening of housing values, the potential effect on consumption remains slightly strong. It is often easy for us at these meetings to say we’ll have a clearer understanding at the next meeting of where we are; but although the next meeting answers this meeting’s questions, it also raises new questions. However, in this instance, we may have more reason than not to make that point. The January jobs number will be out on Friday. If the initial claims number has any predictive power, we may see a strong report. I couldn’t help but notice the juxtaposition of the initial claims chart next to the GDP number as an indication that it’s one that will be looked at carefully. Also, given the magnitude of the change in the prior-period GDP, the revised GDP number for the fourth quarter may be much different from the preliminary number. Also, between now and the next meeting, our new Chairman will be making a semiannual presentation to the Congress on the state of the economy, with an opportunity to be more definitive than we can perhaps be at this meeting. In conclusion, I suggest that we make the obvious move and raise our target ¼ point but not be any more definitive or predictive than necessary in the accompanying statement. I support President Yellen’s suggestion for flexibility in our description today. And I share with everybody else the honor of having worked with you for these four years that I’ve been here." FOMC20070321meeting--203 201,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. I’m very comfortable with the center of gravity in this discussion. The boundaries have shifted just a bit, and we face a little more uncertainty on the growth front. But I think there’s still asymmetry in the balance of risks that we face, and we need to continue to highlight the risk that inflation may not moderate enough. The probability that we will tighten further has significantly diminished, but I think our expectations about what makes sense for policy are still above the market’s expectations. I don’t think that situation means that we need to try to push the market’s expectations up to ours. By adjusting the statement slightly in the direction of neutral, we face the risk that we all acknowledge that the market will price in more easing than they already have. But it is better to live with that risk than to preserve a formulation that implies a probability of further tightening that I don’t think is justified. We need to give ourselves the flexibility now to move to neutral sooner than might have seemed likely. Therefore, the broad outlines of alternative B make sense to me. On section 2, as Don said, the reason for putting more texture about the basis for our forecast going forward was, in part, to counteract the fact that we’re suddenly darker about the near- term outlook. The absence of any texture on our forecast makes the statement darker and conveys more concern. So although I like minimalism and although a lot of sensible things have been said about the specific references to financial conditions and housing, I think there’s some value in having more texture about the basis for our view. I’m not as troubled about the reference to financial conditions as many of you are. We could modify the rationale to say “supported by income gains, overall financial conditions, and the gradual waning” so that the characterization of financial conditions is implicit rather than explicitly favorable. But I don’t think that doing so would go far in meeting the concerns expressed around the table. So I would be fine with the Moskow formulation, stopping after “quarters.” I think the rest of the wording has it right. On “predominant” versus “principal,” let me give just the following argument. I don’t believe that a plain language reading of the two words justifies the conclusion that “principal” will be read as softer than “predominant.” People disagree, and in answering the question about what we expect to achieve by changing “predominant” to “principal,” I’m not sure we’d win the basic argument that people would say, “Yeah, it’s softer.” So, on the argument of consistency, I would stay with “predominant.” I don’t think our views of the risks on the inflation front have shifted significantly since the testimony, and so I don’t have any problem with maintaining that. Thank you, Mr. Chairman." FOMC20070807meeting--195 193,MS. DANKER.," I’ll read the directive wording from the Bluebook and the balance of risk assessment from Brian’s handout. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent. “Although the downside risks to growth have increased somewhat, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.” Chairman Bernanke Yes Vice Chairman Geithner Yes President Hoenig Yes Governor Kohn Yes Governor Kroszner Yes Governor Mishkin Yes President Moskow Yes President Poole Yes" FOMC20071031meeting--37 35,MR. HOENIG.," Thank you, Mr. Chairman. I will talk a little about the District this time. It continues to perform well, with ongoing weakness in the housing sector offset by strength in agriculture and energy. As has been true for a while, construction activity remains mixed, with weakness in residential construction offset by continued strength in commercial construction. In terms of residential construction, both the number of single-family permits and the value of residential construction contracts declined in September, and home inventories rose with slower home sales, as is happening elsewhere. However, District home prices measured by the OFHEO index edged up in the second quarter and remain stronger than in the nation as a whole. On the commercial side, after a robust spring, construction activity has slowed but has remained solid. Energy regions, such as Wyoming, report strong activity. But even in the non-energy regions, activity remains solid. Office vacancy rates were stable, and absorption rates declined. In addition, developers reported more-stringent credit standards, and they expected credit availability to remain tight. Consumer spending softened in September. Mall traffic was flat, and retailers reported that sales were down slightly. In addition, auto dealers reported that sales fell further in September as high gasoline prices cut demand for our SUV sales and for vans. In other areas, though, activity appears to remain at least moderate. For example, travel and tourism remain healthy. In addition, manufacturing activity picked up slightly in October. Solid increases among producers of durable goods offset a weakening among producers of food, chemical, and other nondurable goods. Even so, purchasing managers remain optimistic about future activity, as most forward-looking indexes strengthened or held steady. Finally, we continue to see strength in agriculture and energy. District producers are selling a bumper crop at high prices as poor crop conditions in the rest of the world trimmed global inventories and boosted export demand. In addition, robust meat demand kept cattle and hog prices above breakeven levels. The sharp rise in farm income led to a surge in farm capital spending in the third quarter and is expected to rise further in the fourth quarter. Turning to the national economy, my outlook for growth is basically unchanged from our last meeting. Generally speaking, economic indicators have been a bit stronger over the intermeeting period, as described here, but financial markets continue, obviously, to exhibit some stress. The senior loan officer survey suggested moderate tightening of credit conditions. That is consistent with our estimates of slower growth in the current quarter. As before, though, I remain more optimistic than the Greenbook about both the near-term outlook and the longer-run growth potential for the economy. Specifically, I think growth over the forecast period will average about 2½ percent. My forecast is based on maintaining the fed funds rate at its current level of 4¾ percent through the middle of next year before reducing it to its more neutral level late next year or early 2009. With regard to trend growth, I continue to expect a decline in potential growth from about 2¾ percent to 2½ percent by 2010. Disappointing housing data have led me to mark down my near-term forecast for residential investment. I continue to expect that residential investment will decline through the first part of next year before turning up in the second half. Also, after strong growth in the first half of this year, nonresidential construction is likely, perhaps, to slow significantly over the next year and a half. Supporting growth in the near term will be moderate growth in consumer and government spending along with strength in exports driven by the lower dollar and robust foreign growth. Turning to the risks to the outlook, I believe they remain on the downside as far as real output but have not worsened noticeably since our last meeting, especially with that action. I believe that construction, both residential and nonresidential, and slower consumer spending from higher energy prices constitute the main risks to the outlook. With regard to the inflation outlook, recent data on core inflation continue to be, as noted here, favorable. I expect core PCE inflation to average about 1.8 percent over the forecast period—remember, assuming no change in the fed funds rate—but I also expect that overall PCE inflation next year will moderate as the effects of higher food and energy prices wear off. However, I do remain concerned about the upside risk to inflation as well. Greater dollar depreciation and higher energy and commodity prices, along with greater pass-through from all three, could push inflation higher for a period of time. In addition, I am also concerned about the implications of the gradual upcreep in the TIPS measures of expected inflation for the long-run path, and I am receiving more anecdotal information, in discussions with individuals in our region, about a change in expectations about inflation as they continue to deal with some rising prices in materials and other goods. Thank you, Mr. Chairman." FinancialCrisisReport--244 The Subcommittee’s investigation uncovered a host of factors responsible for the inaccurate credit ratings issued by Moody’s and S&P. One significant cause was the inherent conflict of interest arising from the system used to pay for credit ratings. Credit rating agencies were paid by the Wall Street firms that sought their ratings and profited from the financial products being rated. The rating companies were dependent upon those Wall Street firms to bring them business and were vulnerable to threats that the firms would take their business elsewhere if they did not get the ratings they wanted. Rating standards weakened as each credit rating agency competed to provide the most favorable rating to win business and greater market share. The result was a race to the bottom. Additional factors responsible for the inaccurate ratings include rating models that failed to include relevant mortgage performance data, unclear and subjective criteria used to produce ratings, a failure to apply updated rating models to existing rated transactions, and a failure to provide adequate staffing to perform rating and surveillance services, despite record revenues. Compounding these problems were federal regulations that required the purchase of investment grade securities by banks and others, thereby creating pressure on the credit rating agencies to issue investment grade ratings. Still another factor were the Securities and Exchange Commission’s (SEC) regulations which required use of credit ratings by Nationally Recognized Statistical Rating Organizations (NRSRO) for various purposes but, until recently, resulted in only three NRSROs, thereby limiting competition. 954 Evidence gathered by the Subcommittee shows that credit rating agencies were aware of problems in the mortgage market, including an unsustainable rise in housing prices, the high risk nature of the loans being issued, lax lending standards, and rampant mortgage fraud. Instead of using this information to temper their ratings, the firms continued to issue a high volume of investment grade ratings for mortgage backed securities. If the credit rating agencies had issued ratings that accurately exposed the increasing risk in the RMBS and CDO markets and appropriately adjusted existing ratings in those markets, they might have discouraged investors from purchasing high risk RMBS and CDO securities, slowed the pace of securitizations, and as a result reduced their own profits. It was not in the short term economic self interest of either Moody’s or S&P to provide accurate credit ratings for high risk RMBS and CDO securities, because doing so would have hurt their own revenues. Instead, the credit rating agencies’ profits became increasingly reliant on the fees generated by issuing a large volume of investment grade ratings. 954 See, e.g., 1/2003 “Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets,” prepared by the SEC, at 5-6 (explaining how the SEC came to rely on NRSRO credit ratings); 9/3/2009 “Credit Rating Agencies and Their Regulation,” report prepared by the Congressional Research Service, Report No. R40613 (revised report issued 4/9/2010) (finding that, prior to the 2006 Credit Rating Agency Reform Act, “[t]he SEC never defined the term NRSRO or specified how a CRA might become one. Its approach has been described as essentially one of ‘we know-it-when-we-see-it.’ The resulting limited growth in the pool of NRSROs was widely believed to have helped to further entrench the three dominant CRAs: by some accounts, they have about 98% of total ratings and collect 90% of total rating revenue.” 9/3/2009 version of the report at 2-3). CHRG-111hhrg48874--18 Mr. Long," Chairman Frank, Ranking Member Bachus and members of the committee, my name is Tim Long. I am the Senior Deputy Comptroller for Bank Supervision Policy at the OCC. I appreciate this opportunity to discuss the OCC's role in ensuring banks remain safe and sound, while at the same time meet the credit needs of their communities and customers. The last few months have underscored the importance of credit availability and prudent lending to our Nation's economy. Recent actions to provide facilities and programs to help banks strengthen their balance sheets and restore liquidity to various credit segments are important steps in restoring our banking system and we support these initiatives. Nonetheless, the current economic environment poses significant challenges to banks and their loan customers that we and bankers must address. As a bank examiner for nearly 30 years, I have experienced firsthand the importance of the dynamics between bankers and examiners during periods of market and credit stress. One of the most important lessons I have learned is the need to effectively communicate with bankers about the problems facing their institutions and how we expect them to confront those problems without exacerbating the situation. Delay or denial about conditions by bankers or regulators is not an effective strategy. It only makes things worse. Against that backdrop, here are some facts that bankers and regulators are facing today: First, asset quality in many bank loan portfolios is deteriorating. Non-performing loan levels are increasing. Borrowers who could afford a loan when the economy is expanding are now having problems repaying their loans. Increased levels of non-performing loans will likely persist for some time before they work through the banking system. Second, bankers have appropriately become more selective in their underwriting criteria for some types of loans. Where markets are over-lent or borrowers overleveraged, this is both prudent and appropriate. Third, loan demand and loan growth have slowed. This is normal in a recession. Consumers cut back on spending; businesses cut back on capital expenditures. What is profoundly different in this cycle has been the complete shut-down of the securitization markets. Restoring these markets is a critical part of stabilizing and revitalizing our financial system. Despite these obstacles, bankers are making loans to creditworthy borrowers. The bankers I talk with are committed to meeting the credit needs of their communities, and they recognize the critical role they play in the wellbeing of our economy. Simply put, banks have to lend money to make money. The OCC's mission is to ensure that national banks meet these needs in a safe and sound manner. This requires a balance: supervise too lightly, and some banks will make unsafe loans that can ultimately cause them to fail; supervise too strictly, and some banks will become too conservative and not make loans to creditworthy borrowers. We strive to get this balance right through strong and consistent supervision. In the 1980's, we waited too long to warn the industry about excesses building up in the system which resulted in bankers and regulators slamming on the brakes once the economy turned down. Because of this lesson, we have taken a series of actions starting as early as 2003 to alert bankers to the risks we were seeing and to direct them when needed to take corrective actions. Today, our message to bankers is straightforward. Make loans that you believe will be repaid, don't make loans that are unlikely to be repaid, and work constructively with borrowers who may be facing difficulties with their obligations, but recognize repayment problems and loans when you see them. Contrary to some press reports, our examiners are not telling bankers which loans to approve and which to deny. Rather, our message to examiners is this: Take a balanced approach in your supervision. Communicate concerns and expectations clearly and consistently. Provide bankers a reasonable time to document and correct credit risk management weaknesses, but don't hesitate to require corrective action when needed. It is important to keep in mind that it is normal for our banks to experience an increase in problem loan levels during economic downturns. This should not preclude bankers from working with borrowers to restructure or modify loans so foreclosure is avoidable wherever possible. When a workout is not feasible, and the bank is unlikely to be repaid, examiners will direct bankers to have adequate reserves and capital to absorb their loan losses. Finally, the reality is that some community banks are so overextended in relation to capital and reserves, the management needs to reduce the bank's exposures and concentrations to ensure the long-term viability of the bank. In all of these cases, our goal is to work constructively with bankers so that they can have the financial strength to meet the credit needs of their communities and borrowers. Thank you, and I will be happy to answer any questions. [The prepared statement of Mr. Long can be found on page 132 of the appendix.] " CHRG-110hhrg46594--68 Mr. Campbell," Thank you, Mr. Chairman. Gentlemen, before I lost my mind and went into politics, I spent 25 years in the retail car business, most of that time as a dealer principal and dealer owner. Amongst the franchises I held General Motors, Saturn, Buick, GMC trucks, and Saab, Ford, Lincoln, Mercury, and Mazdas, quasi Fords. Sorry, no Chrysler, Mr. Nardelli. I learned a few things about the car business in that 25 years, but today I just have a few questions for you, and I will just listen. You are asking for a bridge loan, and I think a lot of people want to know what does the other side of the bridge look like. With the exception--let me go back. You know, in my 25 years, I lived through gas price spikes, I lived through credit shortage, and I lived through recessions in my dealerships. We have all three of those at once today, which is certainly the first time in my memory that has happened and I believe the first time in my lifetime; and I would argue that that is why the industry has been so hard hit, because there have been three different factors all convening all at the same time. With that being said, with the exception of the one quarter that Mr. Mulally referenced and, obviously, Mr. Nardelli, we don't know entirely what your earnings were, that the three companies were not making money before those three problems hit. So what are you going to do differently than what you perhaps were planning to do 6 months ago? As you mentioned, Mr. Mulally, you had a plan to come out of this. But these things have hit. They have happened. Conditions are worse. We will recover at some point. The economy will. But you go through a much more difficult time. What are you going to do differently than was your plan to change the other side of that bridge? All three of you, in whichever order you would like to respond. " FOMC20080805meeting--117 115,MS. PIANALTO.," Thank you, Mr. Chairman. My outlook for economic growth and inflation over the next few years is broadly similar to the one that I held last meeting, although I think that the prospects for both inflation and economic growth in the near term have deteriorated since June. To a close approximation, my outlook ends up looking very similar to the Greenbook's baseline scenario. The most significant change I am making to my outlook is to mark down the prospects for business fixed investment this year and next, based on the reports that I am hearing from the manufacturers in my District. There is an interesting short-term/long-term dynamic taking place in the manufacturing sector. The manufacturing CEOs with whom I have spoken say that over the long term they are very bullish on America. The dollar depreciation, increased transport costs, and rising wages in China all favor more U.S.-based production. A senior executive from Alcoa told me that, in his 35 years of working in the manufacturing sector, he has never seen the fundamentals point so strongly toward the United States as a profitable location for manufacturing. The short term, however, presents a more mixed picture for manufacturers. Although some industries, such as power generation equipment and aerospace, are running flat out and expect to continue doing so, companies in other manufacturing industries have received or expect to receive order cancellations. In particular, the manufacturers that supply the automotive and commercial construction sectors are reporting a worsening outlook. Perhaps the best way to summarize the sentiments that I am hearing from manufacturers is to say that they see a bright future but they see challenging conditions over the next 12 months. We all know that housing markets are extremely weak. Housing prices began their decline earlier in Cleveland than in the rest of the country, and we are now seeing some stability in housing prices. Despite that hopeful glimmer, we have not seen any pickup in home sales. Based on this experience, it seems that we still have a long way to go nationally before we see any pickup in residential construction. In regard to financial markets, my chief concern is that lending is going to be constrained by lenders needing to maintain sound capital ratios in the face of asset write-downs and loan charge-offs. Balance sheet constraints and a declining risk appetite on the part of bankers mean that some worthy borrowers are going to be rationed out of credit markets, further restraining economic activity. Turning to inflation, I anticipate that price pressures will intensify further before we see some relief, just as the Greenbook baseline scenario depicts. Manufacturers are still raising their prices in response to rising prices for raw materials that they purchase. Some companies have had fixed-price contracts in place for five and ten years, and as these contracts mature, the companies are passing on huge price increases to their customers. Consequently, I think that even after a point at which energy and commodity prices flatten out, prices at the wholesale and retail levels are likely to adjust upward for a while longer. I just said that manufacturers are expecting some challenging times ahead. One reason is that many of them are caught between weakening demand conditions and soaring input costs. Sherwin-Williams represents an extreme case, but I think it illustrates the situation pretty starkly. The CEO of Sherwin-Williams told me last week that their business is down more than 20 percent in sales channels both to new construction and to existing homes. They have been in business for 126 years, and the last time this occurred was during the Great Depression. Despite these dismal sales, they are having to raise prices. The CEO told me that the company typically raises prices once a year, but in July they announced their third price increase this year. In the entire history of the company, they have never before had three price increases in one year. So I continue to see the risk to my projection for output as being to the downside for the reasons that we have been discussing for some time--high energy prices, severe financial stress, and a depression in the housing markets. The risk to my inflation outlook is weighted to the upside because I am concerned that inflation could remain elevated for too long, potentially destabilizing inflation expectations. The Greenbook baseline scenario expects the near-term inflation picture to worsen in the second half of this year before improving gradually over the entire forecast period. This pattern is a concern to me. In that environment, I worry that inaction on our part before next year could be seen as complacency on our part. So when I stack up the two risks against one another, I regard them as fairly equal right now. But my outlook is conditioned on a federal funds rate path that begins to increase about a quarter earlier than called for in the Greenbook baseline. I will speak to the relevance of this factor when we discuss monetary policy in the next go-round. Thank you, Mr. Chairman. " FinancialCrisisReport--357 Gemstone 7’s assets were assembled in late 2006 and early 2007, when the mortgage market was deteriorating and subprime mortgages were experiencing record delinquency rates. The CDO posed a host of risks due to both the state of the market and the poor quality of many of its underlying assets. Credit Report. In December 2006, Mr. Lamont’s CDO Group prepared a Credit Report for Deutsche Bank’s credit risk management group to obtain internal approval for the securitization of Gemstone 7. 1390 The Credit Report noted the following business risks for Deutsche Bank regarding Gemstone 7, including the possibility that the bank would be unable to sell $400 million of the Gemstone securities, which carried “significant” risk: • “The portfolio is concentrated on RMBS obligations, with 67.6%, 20.2% and 1.9% of the RMBS exposure represented by 2005, 2006, and 2007 vintages, respectively, which results in significant vintage risk.” • “RMBS accounts for ~90.0% of the initial collateral portfolio.” • “All unsold tranches have been taken back by HBK except for the Class A-1B ($400mm). Currently, we are working with [redacted] to see if they will be interested in taking the tranche. The plan for distribution if [redacted] decides not to take the tranche, will be a senior sequential repack. The Class A-1B will be broken into two tranches. DB will take the senior part (Class A-1B(i) $200mm) and HBK will take the bottom part (Class A-1B(i) $200mm). Once the repack is setup, then DB will try to syndicate the Class A-1B(i).” 1391 The business risks described in the internal Deutsche Bank credit report relating to “significant vintage risk” for the 2005, 2006, and 2007 vintage RMBS securities 1392 were not disclosed in the Gemstone 7 offering materials given to investors. Although the March 15, 2007 Offering Circular contained a “Risk Factor” section describing multiple risks associated with an investment in Gemstone 7, including those associated with residential asset backed securities, the Offering Circular was silent with respect to the above risks identified in the Credit Report, which were highlighted for Deutsche Bank management. 1390 Id. See undated Gemstone 7 Securitization Credit Report, MTSS000011-13 and 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71. The 12/20/2006 Credit Report appears to be an earlier version of the document. 1391 Gemstone 7 Securitization Credit Report, MTSS000011-13. 1392 Id. CHRG-111shrg50815--83 Mr. Levitin," Yes. As the Chairman noted, all credit card loans are stated income loans. They are all liar loans. When I get a credit card solicitation, I fill in what my income is, there is no way to check on that. The credit card issuers might look at a credit report, but that doesn't say what my income is. That only says whether I have been paying past bills. So if they are looking to be repaid from a future income stream, there is no way to tell. Senator Tester. Right. " FOMC20070131meeting--144 142,MR. PLOSSER.," Thank you, Mr. Chairman. Conditions in the Third District have continued to evolve much as they have for most of the past several months. Economic activity is still expanding. I think I can use the word “moderate”—I don’t think anybody else has used that yet, and our contacts expect the pace to be maintained in the coming months. There has been little change in the pattern of activity over the sectors. Retailers in our region indicated that their holiday sales were about as they expected or somewhat better. Housing continues to weaken at a somewhat orderly pace, but there are signs of stabilization of demand. Inventory has remained elevated, and construction continues to decline. However, the weakness in residential construction is being offset by continued strength in nonresidential construction. Office vacancy rates continue to decline in Philadelphia and in the near suburbs as well. The net absorption of office space has increased for the past twelve quarters. Manufacturing activity in the region hit a soft spot in the fall, as I indicated in previous meetings, but our most recent Business Outlook Survey, in January, presented somewhat positive but also somewhat mixed signals. The general activity index returned to positive territory with a reading of plus 8, indicating a slight increase in manufacturing activity, and there was a significant rebound in shipments. New orders, however, remained close to zero. That’s somewhat of an aberration because new orders and shipments tend to move very much together, and so there are some inconsistencies there, which is why I said the situation is a bit mixed. According to our survey, however, the firms expect a rebound of general manufacturing activity and orders over the coming six months. Indeed, most of our business contacts see moderate growth in the region continuing for the foreseeable future. Their positive attitudes are consistent with the recent positive news we’ve had about conditions in the nation. Firms remain concerned about their ability to hire both skilled and unskilled labor. Labor markets are tight for many of the reasons that President Minehan described in New England; we have some of the same things going on in the Third District. Regarding national conditions, the unusually warm weather in December may have temporarily buoyed some of our numbers; but based on incoming information, I’ve become increasingly confident that the national economy has a positive underlying momentum. At the time of our last meeting, there was a contrast between the mixed data on consumption and production and the relatively strong indications from the labor market. The picture that appears to be emerging from the latest economic information is one of stronger underlying growth that has been temporarily weakened by housing and autos. There is little, if any, evidence that the housing and auto corrections are spilling over into the other sectors of the economy. We’ve been looking for those spillovers for the past six months and have yet to see any significant evidence that they are occurring or are about to occur. Of course, spillovers may yet materialize with a long lag, but that likelihood to my mind is diminishing as we have begun to see some hopeful signs of stabilization in housing. Labor market conditions remain firm, and manufacturing indicators improved in December as did capital goods orders. Although I didn’t talk to the chairman of Disney, I did talk to a small manufacturing firm with total revenues that come to $2 million. He has been very positive about the outlook. His sales depend a lot on construction, and he said that, after the most miserable August and September he had ever seen in his twenty years of running the business, the pickup began in late November, continued through December, and has continued into January as well. Other contacts from banks, particularly credit card issuers to whom I’ve talked, suggest that banks are seeing numbers coming across their books on credit card purchases continuing to be strong even after Christmas. So that also is good news. All of this suggests that the downside risks to growth have receded since our last meeting. I believe this is the market’s assessment as well, as expectations of future policy firm. My outlook is that the economy will return to trend growth, which I put at about 3 percent this year, and will continue at that pace into 2008. Of course, as everybody has indicated, that’s a little stronger than the Greenbook’s outlook, and it is, again, based on my view that potential growth or trend growth is somewhat higher than the Greenbook has stated. I expect the unemployment rate to rise slightly, maybe to 4.8 percent by the fourth quarter of this year, and then to stabilize into next year. I think this is going to be accompanied by employment growth of nearly 1 percent, and again, that’s what accounts for the difference in the trend growth. I anticipate a decline in core PCE inflation of about 0.4 percent by 2008. I would like to underscore that this forecast is not driven by a lower pass-through of oil prices, which have declined. My reading of the empirical evidence, including work done by some people on the Philadelphia staff, is that it’s very difficult to attribute movements in core inflation of six months to twelve months or longer periods to changes in oil prices. In fact, there’s growing empirical evidence that neither movements in oil prices nor Phillips curve type factors significantly improve our root mean square error forecasts of core inflation two or more quarters ahead. I note that this refers to forecasts of six months or longer and not to short-run high-frequency movements. This suggests that we should be careful in the language we use describing the reasons for our projections of future inflation to avoid perpetuating views of inflation processes that we can’t empirically substantiate. In my view, core inflation will not come back down until monetary conditions, which I believe have been very accommodative over the past few years, have tightened sufficiently. The Greenbook forecast has a slightly smaller decline in core PCE inflation to about 2 percent in 2008, but incorporates a less restrictive monetary policy than I believe is likely to be appropriate given my view of the strength of the underlying economy and of the fundamentals that we are seeing. Indeed, over the past two meetings, my feeling was that the slowdown in economic activity that we might be seeing, combined with a constant fed funds rate, might have been enough to bring inflation back to a more acceptable level. Now I’m less convinced that price stability will be achieved without further action on our part some time later this year. But I will leave that discussion to the policy go- round. Thank you." CHRG-111shrg50815--24 Mr. Zywicki," Mr. Chairman and members of the Committee, it is a pleasure to appear before you today. Let me make clear at the outset, I have no relationship with the credit card industry. I fight with them just like everybody else does. I disagree with them, just like any other company from which I buy goods and services, and you may find this hard to believe, but sometimes I even disagree with my elected representatives on various issues. And I am really quite ruthless and not the slightest bit sentimental about leaving one card and switching to another if a better deal comes along. I don't care whether the industry makes a lot of money or a little bit of money. What I care about is maximizing consumer choice and maximizing competition in a manner that will be consumer welfare-enhancing, and I fear there are many provisions in this legislation that may have unintended consequences that will lead to higher interest rates for consumers, will stifle market and regulatory innovation, and will restrict consumer access to credit at a particularly inopportune time. Unlike almost any other good or service, credit card issuers are forced to compete for my loyalty every time I pull out my wallet to make a payment. I have got four credit cards. I decide at any given time which one is the best one for me to use, whether I am buying gasoline or shopping online. In such a competitive environment, credit card issuers face relentless competition to retain my loyalty, and as I said, I am not the slightest bit sentimental about switching if a better deal comes along. Federal Reserve surveys indicate that 90 percent of credit card owners report that they are very or somewhat satisfied with their credit cards, versus 5 percent who are somewhat dissatisfied and only 1 percent, that is one out of 100, who say that they are very dissatisfied with their credit cards. Moreover, two-thirds of respondents in a Federal Reserve survey also reported that credit card companies usually provide enough information to enable them to use credit cards wisely, and 73 percent stated that the option to revolve balances on their credit cards made it easier to manage their finances, versus 10 percent who said this made it more difficult. So let us not throw out the baby with the bath water. Nonetheless, the myriad uses of credit cards and the increasing heterogeneity of credit card owners has spawned increasingly complexity in credit card terms and concerns about confusion that may reduce consumer welfare. Nonetheless, we should not sacrifice just for the sake of making credit card simpler some of the benefits that we have generated from credit cards. Consider some of the more troubling provisions in the legislation to my mind. First, there are some provisions that will likely lead to higher interest rates and other costs for consumers. For instance, and many of these are in the Federal Reserve rules but I still am troubled by them, and to the extent that they are phased in rather than posed immediately, I believe that will be better for consumers. First, for instance, it prohibits the application of any rate increases on an outstanding balance on credit cards, often called retroactive rate increases. The way credit cards operate is they are revolving credit. They are month-to-month loans. That means at any given time, I can cancel my card and go to a lower interest rate card. To the extent that issuers are unable to raise the interest rate when situations change but I am allowed to switch to a lower interest rate when situations change, the end result of that is that issuers are going to be less likely to offer lower interest rates on the front end. If I can lower my interest rate but it can't be raised if circumstances change, they are going to be less likely to offer lower rate interest cards. Second, the provision that has to do with application on outstanding balances suffers from the same sort of problem. Second, I am concerned that some of the things in this legislation will stifle innovation. For instance, the provision that requires an ongoing payoff, a timing disclosure that includes, for instance, a statement to the consumers how long it would take to pay off the card balance by only making the minimum payment. This would go on every billing statement. According to research by Federal Reserve economist Thomas Durkin, this provision would be of interest to approximately 4 percent of credit card users, being those who intend to pay off their balance by making the minimum payment and intend to stop using the card. It is an open question whether or not it is worth mandating a brand new disclosure for 4 percent of consumers, much less one that would be conspicuously disclosed. Why is that a problem? Because the more things that you require to be disclosed and the bigger you require it to be disclosed, the more distracting and more difficult it becomes for consumers to find out what they actually want. More fundamentally, I think this illustrates a one-size-fits-all strategy to consumer protection that is not accurate in the context of credit cards. The reason why credit cards are so complicated today is because consumer use of credit cards is so multi-faceted. Consumer cards offer an endless array of terms that respond to the endless array of demands of different consumers. Some consumers never revolve. Some consumers revolve sometimes. Some consumers revolve all the time. I never revolve. I have no idea what my credit card interest rate is. I don't care. I don't shop for a card on those terms. I care about what my annual fee is and what my benefits are. To the extent that we mandate certain disclosures, it makes it more difficult for consumers to shop on the terms that they actually want, and the empirical evidence on this is clear. Consumers do shop on the terms that they want. Those who revolve, unlike me, do know what their interest rate is, by and large, and they shop very aggressively on that. The best evidence we have is that those who revolve balances actually have a lower interest rate on their credit card than those like me who don't pay interest and so don't shop on that particular term. To the extent, then, that we also place limits on penalty fees and that sort of thing, we are going to reduce risk-based pricing by requiring interest rate raises for everybody else. The final thing I would like to close on is the concern that this might reduce credit access. We know what has happened during this past year as credit card access has dried up and credit limits have declined. Reports indicate that middle-class--some people have been forced to go without things they wanted. Other reports indicate that those who are unable to get credit cards have been, for instance, forced to turn to layaway plans. They brought back layaway this fall because people couldn't get credit cards. Other people have had to turn to payday lenders. Other middle-class people have turned to pawn shops. To the extent that the impact of this law is to reduce access to credit, it will harm those who we intend to help, and in particular, I would urge caution, although it is obvious college students often misuse credit cards, I would urge caution at this particular time at doing things that might limit access to credit for college students. We know that the student loan markets are not performing very well right now either, and we know that a lot of college students drop out when they can't get access to credit. So it may be that on net, some of those are appropriate, so let us not be overzealous in a way that might lead to reduced access to credit. Thank you. " CHRG-111hhrg53244--195 Mr. Hensarling," Mr. Chairman, in your most recent survey of small businesses finances, I believe the Federal Reserve indicated that approximately 77 percent of small business owners use credit cards. A recent report in USA Today has indicated that in the first 4 months of this year alone, we have seen a 38 percent drop in the issuance of new credit cards. Now, presently Congress is considering legislation aimed at consumer financial products. But given that a large number of small business owners use credit cards for business purposes, might an unintended consequence of the wrong legislation lead to a further contraction of credit to small business? " FOMC20060808meeting--29 27,MS. MINEHAN.," I have a follow-on question to Sandy’s. I know how the benchmark GDP revisions work into your forecast. But if you look just at the headline numbers, we seem to have the worst of all circumstances for a central bank: a good deal slower growth for a number of reasons—the benchmark being one of them—even though all the output gaps and everything else remain relatively the same, slower headline growth in both GDP and consumption, and higher inflation. This is not an easy set of circumstances by any means. One thing I am concerned about, like Sandy, is the speed with which you have consumers reacting in their consumption to potential GDP changes. You haven’t changed the saving rate that much from your earlier forecast, but you do get the 0.3 percentage point out of GDP growth. I was just wondering about your thoughts on that—the reaction seemed fast. Second, outside of a recession, have we ever seen this kind of decline in real estate investment in a period of growth? We were trying to find it, but it’s hard to sort through cause and effect here. The decline seemed very large in terms of the negative real estate investment. Finally, Karen mentioned that we haven’t seen wage inflation or wage growth outstrip productivity here or in major countries anywhere else in the world. I’m wondering, given all the focus on the fact that median family incomes are not growing on a real basis, whether there is at least some chance that we’re going to start seeing an increasing return, particularly for skilled people, which everybody tells you they can’t find." CHRG-111hhrg48874--37 Mr. Marchant," Thank you, Mr. Chairman. I think one of the big mixed messages that the public is getting is they're picking up the newspaper and they're reading that the Federal Reserve is putting a trillion dollars of liquidity into the system, into the banking system. And they're hearing that there's TARP money going into each of the banks. They're thinking that because of all this money that's going into the banks and the TARP money going into the banks, that there surely must be money available at the bank that they can borrow. I don't think they realize that most of this money is going to the loan loss reserve and to rebuild the capital reserves. And if anything, the TARP money, by paying 5 percent on the TARP money, money that costs 5 percent--5 percent is more than the bank's cost of funds right now. So their best customers, the customers that your examiners like to see when they come in and crack the books, actually are paying 3 to 3.5 percent on their loans. They are prime plus 1 or 2. So any TARP money used to make a loan to their absolute best customer will be made at a loan value that is less than the cost of funds. So obviously the TARP money, while I believe the Congress felt like that is what the money was going to do, to be put in the system to make more liquidity, it hasn't ended up doing that. And when that public reads that the Fed is putting liquidity into the system, I think the message they think is that there is more money available to borrow. But what the customers in my district are finding out is that they are facing rising interest rates. A lot of the prime borrowers are going back in to renegotiate a line of credit that they have done for 20 years, and they're finding out that instead of having a prime plus 1 or 2 now, there's a floor being put on the amount of the loan that can go down. And in most instances, that floor is now 5 percent. They are the best customers of the bank. And the reasons that are being given are: We have this special assessment coming. Our bank is not going to be profitable next year, because of these special assessments. The other thing that has happened is that there is a definite restriction in the amounts that these lines of credits can grow. So de facto, if a business is doing well and can expand, they're not going to be able to expand their credit line. And most bankers are not expanding credit lines. And then, of course, you have the customers who are going in and finding that their HELOC loans they're having, they're getting letters in the mail that say that their line has been cut; they're getting letters from the credit card companies that are saying the same things. I know that this hearing is not about that. And they're getting extra demands on their collateral. So there are mixed signals that are coming out. I believe sincerely that everyone at this panel today is doing exactly what you feel like is the best thing to do for the system. The borrower does not understand the interplay of all of these things. And frankly, this Congressman does not understand the interplay many times, and does not understand what the benefit to the system is if the headline is that a trillion dollars has been put into the system by the Fed, but my constituents don't find that to be of any benefit to them whatsoever, when they go to the bank and want to borrow money. Thank you, Mr. Chairman. " Mrs. Maloney," [presiding] Thank you. The Chair recognizes herself for 5 minutes, and I welcome all the panelists. I would like to ask Governor Duke, whom I understand has experience as an online banker in commercial banking, do you believe that the Federal Government could or should have taken different actions in the fall or more recently to ensure that credit would be more available? I believe all of us are hearing the same story when we go to the caucus meetings, when we talk to our colleagues on both sides of the aisle, that the credit is just not out there; we need to get the liquidity moving. I'm hearing particularly commercial credit has absolutely dried up; it's very hard to get loans. How effective do you believe that the TALF program and the Public-Private Investment Program will be in opening up credit and allowing financial institutions to lend money? And also last night, I was reading a report where banks used to provide 60 percent of the credit in our country, and now are providing roughly 20 percent, and it has been picked up by other forms of credit. Just your comments in general on these questions. Thank you. Ms. Duke. Mrs. Maloney, thank you. As you know, I was a banker and a community banker for nearly 30 years, and so I'm well aware of the tension that exists between bankers and bank examiners, as well as lenders and borrowers. I think, to your first question, I do believe, I honestly believe that the Federal Government has made every response we can think of to make, in particularly the Federal Reserve, in order to ensure that lending is continuing to take place. And I think if we had not done that, that the circumstances would be substantially worse. Provision of liquidity to banks is critically important in order that they have the funds to lend. The capital that we put into the banks not only strengthens the banks, but also strengthens them in the minds of others who would provide liquidity. And it's the liquidity that really gets lent forward on to borrowers. In addition to that, you're right that the banking system percentage of the credit that was extended has dropped. It dropped to about 30-some percent, anyway below 40 percent, although if you add back the securitization that banks did, they were still probably facilitating more than 40 percent of the credit, going into this recent episode. And so the TALF is really designed to restart securitization markets. And what we have found in our Fed facilities, first with those that were directed at commercial paper, was that by creating a facility to support commercial paper, gradually that market improved. Now, the first version of the TALF is directed at consumer loans, student loans, and small business loans. And, we had the first issuance of TALF, which is $8 billion. It may not sound like a lot in the context of trillions and trillions of dollars, but that is more than had been done in the last 4 months. These are difficult times, they're difficult times for bank examiners, they're difficult times for bankers. I think at the end of the day, probably the best thing we can do is everything that we're doing to improve financial conditions. A lot of the reasons lines get cut is because collateral values have dropped. So if we could put a floor under housing, anything we can do to support mortgage lending and housing will tend to put a floor on the value of housing, and then that stops the value of the collateral from dropping. Same thing with commercial real estate, and we're hearing the same things that you hear on commercial real estate. The securitization market for commercial real estate loans has completely shut down. In addition to new commercial real estate, there are also a number of commercial real estate loans that are currently up for renewal. And, we need to provide for the renewal of those. So we are looking at commercial real estate as part of the TALF in the next version. But again, commercial real estate values are tied to the cash flows of the businesses that operate out of that commercial real estate, and so to the extent that business is down, that retail sales are down, that attendance is down in hospitality areas, that's going to tend to reduce the value of that collateral, and reduce the ability of those owners to borrow and to expand their businesses. " FOMC20080430meeting--91 89,MS. YELLEN.," Thank you, Mr. Chairman. In looking at the latest Blue Chip forecasts for GDP growth, I noted that the range between the highest and lowest is among the largest on record. The 10 most optimistic forecasters are predicting over 2� percentage points faster Q4-over-Q4 growth than the 10 most pessimistic ones. Such forecast dispersion is indicative of the unusually high degree of uncertainty that we are facing. The Greenbook presents one of the most pessimistic economic forecasts; yet I find its recessionary projection quite plausible and see downside risks that could take the economy well below that forecast. Although I found it especially difficult this time to decide on the most likely outcome for the economy, I ended up submitting a forecast that shows somewhat more growth in 2008 than the Greenbook, even though we shared the same assumption concerning monetary policy this year. My forecast projects 2008 growth of � percent. This averages no growth in the first half and 1� percent growth in the second. The unemployment rate increases to just over 5� percent by the end of this year, a bit lower than the Greenbook. In one critical area--namely, the adverse effects of financial sector developments on the real economy--I remain just as pessimistic as the Greenbook. Although the likelihood of a severe financial panic has diminished, the risks are by no means behind us. Moreover, credit conditions have turned quite restrictive. This credit crunch reflects the drying up of financing both for markets that were important sources of business and consumer credit and from banks that are contending with capital-depleting losses and illiquid assets. Among banks, the latest Senior Loan Officer Opinion Survey noted a clear tightening of lending standards, and my own discussions with bankers confirmed this point. They say they are carefully reassessing and significantly curtailing existing home equity lines of credit as well as unsecured consumer loans of all sorts. Banks are also clamping down on the provision of revolving business credit, even to very creditworthy customers. For example, the treasurer of Chevron, a highly rated oil company that, as you can guess given energy prices, has a very strong profit outlook, recently complained to me that banks were reluctant to extend even its credit line. Such reluctance is also evident for lending to students, consumers, and other businesses. The risk of a deepening credit crunch remains as a weak economy--especially with further sharp declines in housing prices--escalates credit losses, harms financial institution balance sheets, and causes them to scale back lending even further. My sense from our business contacts is that their perception of reduced access to credit is causing them to manage their firm's liquidity more carefully and is leading to some deferrals in capital spending projects as a precautionary measure. Certainly the mood is decidedly more pessimistic and cautious. Amid the gloom of the credit crunch, I do see a possible silver lining in that it may amplify the effects of the fiscal stimulus package, and this is part of the reason that my forecasted downturn is a little milder than the Greenbook's. In particular, because of the credit and liquidity considerations, the latest fiscal package could well provide a bigger bang for the buck than the tax rebates in 2001. First, the current tax rebates are more directly targeted at lower-income households, which are more likely to be credit constrained and to spend the cash once it's in hand. Second, given the current tightening of credit availability, households will likely spend an even greater fraction of the tax rebates than they did in 2001. Of course, there is considerable uncertainty about assessing the potential size of these effects. But over the next few months as the checks go out and the retail sales reports come in, we should get a pretty quick preliminary read on how things are shaping up. Regarding inflation, the most worrying developments since we met in March have been the price surges for a wide variety of raw materials and commodities, especially the jump in the price of crude oil. From the U.S. perspective, this run-up in prices represents mainly a classic supply shock, which could threaten both parts of our dual mandate, although the decline in the dollar has slightly exacerbated the severity of the impact. Like the Greenbook, my forecast for inflation does take commodity price futures at face value and foresees a leveling-out of prices going forward. Although I must say, after four years of being wrong, I am beginning to feel like Charlie Brown trying to kick that football. The most recent core consumer price data have shown some improvement, and like the Greenbook, I'm optimistic that core inflation will subside to around 1� percent over the forecast period, assuming that the commodity prices do finally level off and compensation remains well behaved. An interesting analysis by Bart Hobijn of the New York Fed as well as my own staff implies that, in an accounting sense, pass-through from the run-up in oil and crop prices may have boosted core inflation as much as 0.3 percentage point over the past two years. So a leveling-off of these prices could lower not only headline but also core inflation. My core PCE inflation forecast is a tenth or two lower than the Greenbook this year and next also because we assume lower passthrough of the dollar depreciation to non-oil import prices. We have been reexamining the data on this issue and find the evidence quite convincing that pass-through has been quite low recently-- lower, for example, than embodied in the FRB/US model. With respect to inflation expectations, market-based measures have now edged down. We took little comfort from this fact, however, because we had viewed the uptick in inflation compensation in recent months mainly as a reflection of a higher inflation risk premium and not a reflection of higher inflation expectations. I am also somewhat concerned that the median expectation for inflation over the next five to ten years in the Michigan survey has ticked up. " FOMC20070628meeting--218 216,MS. SMITH.," I will be reading the directive from page 29 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” And the risk assessment: “In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” Chairman Bernanke Yes Vice Chairman Geithner Yes President Hoenig Yes Governor Kohn Yes Governor Kroszner Yes President Minehan Yes Governor Mishkin Yes President Moskow Yes President Poole Yes Governor Warsh Yes" CHRG-111shrg56415--246 PREPARED STATEMENT OF THOMAS J. CANDON Deputy Commissioner, Vermont Department of Banking, Insurance, Securities, and Health Care Administrationon behalf of the National Association of State Credit Union Supervisors October 14, 2009Introduction Honorable Chairman Johnson, Ranking Member Crapo and the distinguished members of the Financial Institutions Subcommittee of the Senate Banking, Housing and Urban Affairs Committee, thank you for the opportunity to testify before this Subcommittee on the State of the Banking Industry. I am Thomas J. Candon, Deputy Commissioner of Banking and Securities for the Vermont Department of Banking, Insurance, Securities and Health Care Administration. I am pleased to be here on behalf of state credit union regulators as Chairman of the National Association of State Credit Union Supervisors \1\ (NASCUS). In this prepared testimony, I will share state credit union regulators' perspectives on the condition of state-chartered credit unions and areas for reform.--------------------------------------------------------------------------- \1\ NASCUS is the professional association of the 48 state credit union regulatory and territorial agencies that charter and supervise the nation's 3,100 state-chartered credit unions.--------------------------------------------------------------------------- NASCUS has been committed to enhancing state credit union supervision and advocating for a safe and sound state credit union system since its inception in 1965. NASCUS is the sole organization dedicated exclusively to the promotion of the dual chartering system and advancing the autonomy and expertise of state credit union regulatory agencies. The state credit union system is 100 years old. Today, there are 3,065 state-chartered credit unions with a combined $404 billion in assets.\2\ State-chartered credit unions represent 40 percent of the nation's nearly 7,700 credit unions.--------------------------------------------------------------------------- \2\ As of June 30, 2009.--------------------------------------------------------------------------- At this hearing, the Subcommittee is assessing the state of financial institutions, areas of concern as well as capital and lending needs. In this testimony, I will detail information from state regulators on the following: Condition of state-chartered credit unions Corporate credit union impact Credit union capital needs Regulatory considerations for member business lending Trends and regulatory response Value and strength of state supervisionCondition of state-chartered credit unions Like all financial institutions, state credit unions have been adversely affected by the economic downturn. However, at this point, state natural person credit unions remain generally healthy and continue to serve the needs of their members and their communities. For the most part, natural person credit unions did not engage in many of the practices that have precipitated the current market downturn. Nationally, the average credit union net worth is down to 10.03 percent, with 96 percent of all federally insured credit unions having more than 7 percent in capital as of June 30, 2009. Further, the percentage of delinquent loans is 1.58 percent for all credit union loans. State-chartered credit unions in my state of Vermont have the capability to lend due to an increase in deposits that we attribute to a flight to safety. Consumer loans are available to members although underwriting continues to be based on a member's ability to repay. At this time, Vermont credit unions do not make many member business loans and have nominal commercial real estate loans on their balance sheets. Our regulatory focus is on the amount of capital held by some of our credit unions and the impact of the growing unemployment picture on delinquencies. The capital of Vermont credit unions is affected by the growth of deposits which were up 24.73 percent in Vermont as of June 30, 2009, and the impact of the corporate credit union losses (which I will discuss later). Income is also being reduced as margins are squeezed and credit union members are struggling to make loan payments. In Vermont, our small credit unions like many around the country are not only affected by a downturn in the economy but also by increasing regulatory burden. We continue to see mergers as long-time managers retire and volunteer boards cannot keep up with the increased demands. As state regulators we monitor our credit unions closely. If there is any sign of distress, we have an examiner communicating with the credit union to make sure we understand what needs to be done to correct the problems. As the Subcommittee knows, the effect of the economy on financial institutions varies from region to region. Some regions are weathering significant impacts from the destabilized real estate market, while others are addressing more localized economic issues. In many cases, state regulators are concerned about unemployment and its impact on members' ability to meet their obligations. State regulators are also concerned about the growing number of delinquencies, charge-offs and pressures on earnings, especially in smaller state-chartered credit unions. While loan delinquency and net charge-offs have generally increased for state-chartered credit unions, state regulators indicate that the levels remain manageable. State regulators also report increased scrutiny on consumer credit products, including auto loans, credit cards and other consumer credit portfolios given the nation's economic condition. State credit union regulators are cognizant of credit unions' future financial performance as commercial credit problems begin to affect consumer credits. The weak economy creates a tightening of commercial credit, an issue being closely monitored by state regulators. Some states, including my home state of Vermont, have not experienced the fallout from commercial or subprime lending as our state-chartered credit unions did not engage in those activities. State regulators continue to encourage their credit unions to exercise sound underwriting, proper risk management and due diligence, the elements that have kept credit unions in a better position throughout this economic downturn. Further, state regulators are monitoring red flags closely, fully utilizing offsite monitoring and using early warning systems to detect risk. The growing trend toward consolidation is also on the minds of state regulators as credit union mergers continue to occur, both voluntarily and for regulatory purposes. As economic pressures persist, finding suitable merger partners may become more difficult. State regulators recognize this dilemma and see merger issues as an ongoing concern in 2010. In addition, growth is an issue state regulators are paying close attention to in today's environment. The National Credit Union Administration (NCUA) reported in its Financial Trends in federally Insured Credit Unions for January-June 2009 an annualized asset growth rate of 14.53 percent. This growth gives rise to concerns about interest rate risk and the need to ensure quality asset/liability and balance sheet management among credit unions.Corporate Credit Union Impact As I noted earlier, one of the issues affecting both state and Federal credit unions is the impact of problems in the corporate credit union network. Allow me to elaborate. In addition to direct economic pressures, credit unions are addressing indirect economic pressures by way of the impact of losses from corporate credit unions. The deterioration of asset-backed securities held by two Federal corporate credit unions (U.S. Central Corporate Federal Credit Union and Western Corporate Federal Credit Union) and their consequent conservatorship by the NCUA have resulted in considerable balance sheet impact on natural person credit unions. For the first time in nearly 20 years, the NCUA Board approved a credit union premium in September 2009 with the assessment of 0.15 percent of insured shares. The premium will both restore the National Credit Union Share Insurance Fund (NCUSIF) equity to 1.30 percent and begin to repay a portion of the Temporary Corporate Credit Union Stabilization Fund borrowings from the U.S. Treasury. State regulators, in consultation with Federal regulators, are working to address the impact of corporate losses and to make regulatory improvements to mitigate recurrence. As the NCUA develops its proposed rule for regulation of corporate credit unions, state regulators continue to stress the following principles: Enhance supervision and tighten regulatory standards Properly assess risk problems Preserve equal opportunity for all corporates to compete as long as they remain safe and sound and retain the support of their members Guard against preemption of state authority and homogenization of the corporate system State regulators have also cautioned the NCUA against regulation that would unnecessarily or adversely impact safe and sound corporate credit unions that have properly managed their investments and remain fully supported by their members. NCUA has been working cooperatively with state regulators to institute revisions to the agency's Part 704 corporate credit union regulations to strengthen the safety and soundness of the corporate system. Regulators should continue to focus on ensuring any credit union, natural person or corporate, has robust risk management and mitigation policies in place to balance its investment portfolios. Such policies should include adequate reserves, requisite expertise, meaningful shock testing and valuation mechanisms as well as concentration limits. NASCUS believes there is no question that after recent events corporate credit unions must retain higher capital reserves. NCUA should work with NASCUS and state regulators to develop more comprehensive capital requirements, including risk-based capital. The regulatory capital program for corporate credit unions should consider an institution's status as a wholesale or retail corporate, its mix of products and services (investment, payment systems, pass through, etc.) and establish parameters of actions for state and Federal regulators if capital falls below defined thresholds. Capital is important to both the corporate credit union system and the natural person credit unions that support the corporate credit unions. During the corporate stabilization process, supplemental capital may have mitigated some of the unintended consequences to net worth categories at natural person credit unions. Further, access to a risk-based capital system would foster safety and soundness for the entire credit union system.Credit Union Capital Needs The majority of credit unions are weathering conditions today; however, as stated previously, credit unions' earnings are suffering and credit unions are losing money. We need to act now to ensure credit unions remain as safe and sound as possible. NASCUS has long supported comprehensive capital reform for credit unions and believes that given the current economic climate, reform in this area is critical and timely. Credit unions need more ways to raise capital, notably access to supplemental capital. NASCUS continues to encourage the Senate Banking Committee to consider credit union capital reform as part of its financial reform efforts. Unlike other financial institutions, credit union access to capital is limited to reserves and retained earnings from net income. Since net income is not easily increased in a fast-changing environment, state regulators recommend additional capital-raising capabilities for credit unions. Access to supplemental capital will enable credit unions to respond proactively to changing market conditions, enhancing their future viability and strengthening their safety and soundness. Supplemental capital would serve as an extra layer of protection for the credit union deposit insurance fund as well. Allowing credit unions access to supplemental capital with regulatory approval and robust oversight will improve their ability to react to market conditions, grow safely into the future and serve their members in this challenged economy. It would also provide a tool for credit unions to use if they face declining net worth or liquidity needs. We feel strongly that now is the time to permit this important change. NASCUS follows several guiding principles in our quest for supplemental capital for credit unions. First, a capital instrument must preserve the not-for-profit, mutual, member-owned and cooperative structure of credit unions. Next, it must provide for full disclosures, investor protection and robust safeguards. Prudential safety and soundness requirements must be maintained for these investments and supplemental capital must preserve credit unions' tax-exempt status. Finally, regulatory approval would be required before a credit union could access supplemental capital. It is NASCUS' studied belief that a change to the Federal Credit Union Act could provide this valuable tool to the credit union system without altering the not-for-profit, mutual, cooperative structure of credit unions as tax exempt member owned financial institutions. We realize that supplemental capital will not be appropriate for every credit union, nor would every credit union need access to supplemental capital. This is why NASCUS supports regulator approval as a pre-condition for credit unions issuing supplemental capital. A task force of NASCUS state regulators is currently studying supplemental capital for credit unions with the NCUA. This regulatory group is researching the appropriate regulatory parameters for supplemental capital for credit unions. As this Subcommittee addresses regulatory reform and other legislation this fall, NASCUS encourages favorable consideration of access to supplemental capital for credit unions.Regulatory Considerations for Member Business Lending Credit union member business lending, when conducted within proper regulatory controls, has proved beneficial for credit unions, their members, and their communities. However, while some credit unions are actively engaged in member business lending, many are not. As Congress considers changes to credit unions' member business lending capabilities, state regulators will work with the NCUA in its capacity as the insurer to build regulatory parameters for proper oversight through the examination and supervision process. Further, credit unions must have a thorough understanding of member business lending and be diligent in their written policies, underwriting and controls for the practice to be conducted in a safe and sound manner. From a prudential regulator view, an arbitrary cap on member business lending is less important than proper underwriting and thorough reporting of all business loans.Trends and Regulatory Response I would like to respond to the Subcommittee's request for information regarding developing trends, concerns and state regulatory responses to today's challenges. Rising unemployment continues to be a concern and we expect that it will continue to negatively impact state credit unions well into 2010 as delinquencies and bankruptcies continue to increase. Some state regulators have seen a marked increase in loan delinquencies and net charge-offs at June 2009; however, the levels remain manageable. Earnings pressures continue so credit unions are seeking ways to reduce overhead expenses. Loan demand has slowed somewhat in the mid-to smaller credit unions; a contrast to the increased indirect lending activities experienced in the larger credit unions. State regulators are closely monitoring both lending and investment activities within their credit unions and continue to stress the importance of sound underwriting and due diligence at the board level. State regulators also continue to supervise their institutions closely through offsite monitoring and onsite examinations and visitations. Credit unions need to understand their portfolio makeup and the impact that an increasing rate environment will have on their institutions. Another economic stressor affecting small credit unions is the uncertainty of losing their core field of membership if comprised of select employee groups. Because some small credit unions still rely on one or two employers for their members, if those businesses do not survive, the credit union will not survive either.Value and Strength of State Supervision In this challenged economic environment, state regulators have demonstrated the importance of local supervision of state-chartered institutions and the value of a dual regulatory regime. State regulators are properly tuned into both their institutions and the specific needs of local consumers. Further, state regulators have the expertise to identify risk areas and take enforcement actions where necessary. With respect to consumer protection, state regulators are directly accountable to Governors and state legislatures, who in turn are directly accountable to their consumer citizens. It is for this reason that many states have always emphasized consumer protection along with safety and soundness in financial services oversight. As regulatory modernization efforts are considered by the Senate Banking Committee, we encourage you to retain state supervision and uphold state authority. Further, we ask you to recognize the essential value of dual chartering to financial institution's ability to innovate. Finally, as we talk about dual chartering, I wanted to note our regulatory partners, the National Credit Union Administration. In my state of Vermont, all of my credit unions are federally insured, and therefore subject to share insurance oversight from NCUA in addition to state safety and soundness and compliance regulation and supervision. We work extremely well with NCUA, and I believe our strong cooperative relationship has contributed substantially to the stability of the credit union system in my region. Indeed, this cooperative relationship between state regulators and the NCUA exists throughout the Nation as well. NASCUS would be pleased to provide any additional information you deem appropriate as you work through these matters. While the current economic climate has an unquestionable adverse impact on the state credit union system, I remain confident that the generally sound management of credit unions combined with ongoing vigilant state regulatory oversight has enabled the credit union system to prudently meet their members' needs. Thank you for your attention.RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM SHEILA C. BAIRQ.l. According to a recent New York Times article, about $870 billion, or roughly half of the industry's $1.8 trillion of commercial real estate loans, now sit on the balance sheet of small and medium sized banks. To what extent has TALF encouraged capital to enter the commercial real estate market and what other step should regulators be taking to address this problem?A.l. Small and medium-sized financial institutions hold a significant dollar amount of commercial real estate loans on their balance sheets. Many of these smaller institutions were not active in the commercial real estate mortgage securitization market because of the comparatively small dollar amount of the loans and the nature of customer-focused relationships in community banking. Therefore, we do not believe the TALF has had a significant effect on the availability of credit for smaller commercial real estate loans. In terms of encouraging commercial real estate lending, the Federal banking agencies issued a policy statement on October 30, 2009, titled Prudent Commercial Real Estate Loan Workouts. The Statement encourages banks to continue making good loans to commercial real estateborrowers and work with borrowers experiencing difficulties in their repayment capacity because of the economic downturn. The TALF was designed to increase credit availability for businesses and consumers by facilitating renewed issuance of securities backed by loans to consumers and businesses at more normal interest rate spreads. Based on recent TALF transactions involving commercial real estate mortgage loans, the program appears to have encouraged capital to enter the securitization market. As the Federal Reserve Bank of New York is facilitating the TALF program, the Senator may want to consult with the Reserve Bank on the program's performance and success in encouraging capital to return to the commercial real estate market.Q.2. How will FASB's new rules on off-balance sheet accounting impact financial institution's ability to lend and how do you intend to implement the changes?A.2. Following publication of the Notice of Proposed Rulemaking on September 15, 2009, the bank regulatory agencies received 41 comments from banks, bank holding companies, banking industry associations, mortgage companies, investment and asset management firms, and individuals. A number of commenters indicated that implementation of FAS 166 and FAS 167 without changes to the Agencies' risk-based capital rules would negatively impact financial markets and curtail lending due to higher regulatory capital requirements resulting from the consolidation of significant amounts of assets onto banking organizations' balance sheets. Commenters also argued that such implementation would inappropriately align capital requirements with GAAP's control-based approach to consolidation, in contrast to the credit risk focus of the Agencies' risk-based capital rules. The commenters overwhelmingly supported a delay or phase-in of the regulatory capital requirements resulting from the implementation of FAS 166 and FAS 167. In response the FDIC, working with the other Federal bank regulatory agencies, developed a final rule to better align regulatory capital requirements with the actual risks of certain exposures. Banks affected by the new accounting standards generally will be subject to higher minimum regulatory capital requirements. The final rule provides an optional delay and phase-in for a maximum of 1 year for the effect on risk-based capital and the allowance for loan and lease losses related to the assets that must be consolidated as a result of the accounting change. The final rule also eliminates the risk-based capital exemption for asset-backed commercial paper assets. The transitional relief does not apply to the leverage ratio or to assets in conduits to which a bank provides or has provided implicit support. The Final Rule was passed by the FDIC Board of Directors on December 15, 2009. The rule provides temporary relief from risk-based measures in order to avoid abrupt adjustments that could undermine or complicate government actions to support the provision of credit to U.S. households and businesses in the current economic environment. Banks will be required to rebuild capital and repair balance sheets to accommodate the new accounting standards by the beginning of 2011. The optional delay and phase-in provides capital relief to ease the impact of the accounting change on bank's regulatory capital requirements, and enable banks to maintain consumer lending and credit availability as they adjust their business practices to the new accounting rules. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JOHN DUGANQ.l. According to a recent New York Times article, about $870 billion, or roughly half of the industry's $1.8 trillion of commercial real estate loans, now sit on the balance sheet of small and medium sized banks. To what extent has TALF encouraged capital to enter the commercial real estate market and what other steps should regulators be taking to address this problem?A.l. The Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF) is intended to help make credit available to consumers and businesses by facilitating the issuance of asset-backed securities (ABS) and by improving the conditions for ABS more generally. Until recently, most of the financing conducted with TALF facilities has been concentrated in automobile and credit card ABS securities. The use of TALF to help restart the commercial mortgage-backed securities (CMBS) markets has lagged due to the complexity and level of due diligence required for these types of transactions. The use of the TALF program to assist the CMBS market took a positive step forward on November 16, 2009, when U.S. mall owner Developers Diversified Realty Corp sold $400 million of securities with the help of TALF financing. The $323 million TALF eligible AAA-rated portion was priced at under 4 percent, a much better rate than originally anticipated. This issuance is indicative of a key potential benefit of CMBS TALF: it provides a reasonable cost for senior debt, allowing liquidity to flow back into the market. However, it does not by itself solve the problem of overleveraged borrowers. Since TALF financing is only available for AAA-rated debt, it would likely not directly benefit many of the problem borrowers sitting on the books of the banks today. However, there is an indirect benefit in that it provides market liquidity. Investors will likely use this initial deal as a benchmark, which could encourage other capital into the commercial real estate market. Because of this potential benefit, many market participants would like to see the current deadlines for the TALF program extended beyond the current deadlines of June 30, 2010, for newly issued CMBS and March 31, 2010, for legacy CMBS (i.e., deals issued before 1/1/09). Although there has been some modest improvement in liquidity within the CMBS market, the underlying fundamentals for many commercial real estate segments are still weak with delinquency, nonaccrual, and loss levels still increasing. Ultimately, the credit fundamentals of the industry need to stabilize in order for investors, bankers, and borrowers to fully understand pricing of commercial real estate assets. Banking regulators have a limited ability to directly encourage capital investment into the commercial real estate industry. We are mindful, however, that our actions must not put up unreasonable barriers to take flow of capital. At the OCC, we are encouraging bankers to work with their borrowers, and we continue to stress to examiners the need to take a measured, balanced approach when evaluating loan and borrower performance in this economic environment. We have stressed that we expect and encourage bankers to work with borrowers who may be facing financial difficulty, and to extend new credit to creditworthy borrowers when these actions are done in a prudent and safe and sound manner. In an effort to promote clarity and consistency in the industry, the OCC, in conjunction with the other Federal banking agencies and the FFIEC's State Liaison Committee, recently issued a Policy Statement on Prudent Commercial Real Estate (CRE) Loan Workouts. The policy statement reiterates the agencies' view that prudent CRE loan workouts are often in the best interest of the financial institution and the borrower, and establishes clear regulatory expectations for the industry when working with borrowers. The statement notes that examiners should not criticize banks for engaging in an effective workout program even if the restructured loan has a weakness that results in an adverse credit classification. The statement also reiterates our policy that loans should not be classified simply because the underlying values have declined to amounts that are less than the current loan balance. Instead, classifications must be based on an analysis of the borrower's ability and capacity to repay. To help promote greater consistency both within and across the agencies in making such determinations, the policy statement provides real world examples that our examiners are seeing, and provides guidance on when classification and write-downs are and are not warranted.Q.2. How will FASB's new rules on off-balance sheet accounting impact financial institution's ability to lend, and how do you intend to implement the changes?A.2. Upon implementing FAS 166 and FAS 167, banking organizations will be required to consolidate certain assets and liabilities that are currently held in variable interest entities (VIEs)\1\ that these organizations do not consolidate under current generally accepted accounting principles (GAAP) standards. Certain banking organizations have reported that the consolidation of variable interest entities will result in a significant increase in assets reported on-balance sheet at the time the new accounting standards become effective, which will be January 1, 2010, for banking organizations with a calendar year end. Moreover, except for VIEs that a banking organization consolidates at fair value, consolidation will require the banking organization to recognize an allowance for loan and lease losses for loans held in consolidated VIEs.--------------------------------------------------------------------------- \1\ A VIE is a business structure that allows an investor to hold a controlling interest in the entity, without that interest translating into possessing enough voting privileges to result in a majority. VIEs generally are thinly capitalized entities and include many ``special purpose entities'', or ``SPEs.''--------------------------------------------------------------------------- On September 16, 2009, the Federal banking agencies (Agencies) published in the Federal Register a notice of proposed rulemaking (NPR) regarding the effect of the accounting changes under FAS 166 and FAS 167 would have on capital requirements under the regulatory capital rules. The NPR noted that banking organizations had provided non-contractual support to VIEs that they sponsored in order to prevent senior securities in the structure from being downgraded, thereby mitigating reputational risk and the associated alienation of investors, and preserving access to cost-effective funding. In light of these actions taken by banking organizations, the NPR stated that the Agencies believe that the broader accounting consolidation requirements of FAS 166 and FAS 167 will result in a regulatory capital treatment that more appropriately reflects the risks to which banking organizations are exposed. For these and other reasons, the NPR did not propose changing the regulatory capital rules to mitigate the effect of FAS 166 and FAS 167 on banking organizations' minimum regulatory capital requirements.\2\--------------------------------------------------------------------------- \2\ The NPR proposed the following three changes to the agencies regulatory capital rules: (1) eliminate provisions in the agencies' risk-based capital rules that allow banking organizations to exclude consolidated asset-backed commercial paper (ABCP) program assets from risk-weighted assets and instead assess a risk-based capital requirement against contractual exposures of the organization to such ABCP programs (ABCP exclusion); (2) eliminate a provision in the risk-based capital rules that excludes from tier 1 capital the minority interest in a consolidated ABCP programs subject to the ABCP exclusion; and (3) add a new reservation of authority for the agencies' risk-based capital rules to permit a banking organization's primary Federal supervisor to treat entities not consolidated under GAAP as if they were consolidated for risk-based capital purposes, commensurate with the risk relationship of the banking organization to the entity.--------------------------------------------------------------------------- Before issuing the NPR, the Agencies carefully considered the probable effect on banking organizations' financial regulatory capital ratios and financial condition that will result from implementing FAS 166 and FAS 167. Among other sources, the Agencies considered information obtained through the Supervisory Capital Assessment Program (SCAP)--the recent stress test of the nineteen largest U.S. banking organizations. The SCAP directly considered the likely on-boarding of assets resulting from changes in accounting standards in the assessment of risk-weighted assets and the associated ALLL needs of the stress-tested banks. Moreover, the NPR sought information and comments on a number of questions, including the effect of the accounting changes on banking organizations' financial position and lending, as well as the effect on financial markets. The NPR also solicited comments on whether there are significant costs or burdens associated with implementing FAS 166 and FAS 167, and whether the Agencies should consider a phase-in of the capital requirements that would result from the GAAP changes. Based on an analysis of available information, including comments received on the NPR, the Agencies have finalized work on this rulemaking and expect to publish a final rule in the Federal Register shortly. The Agencies have long maintained that banking organizations should hold capital commensurate with the level and nature of the risks to which they are exposed. The Agencies use risk-based capital rules, supplemented by a leverage capital rule (collectively, regulatory capital rules) to evaluate capital adequacy of banking organizations. In the regulatory capital rules, the Agencies use GAAP as the initial basis for determining whether an exposure is treated as an on- or off-balance sheet asset. In the final rule, the Agencies continue to make use of GAAP concepts within the regulatory capital regime by recognizing VIEs consolidated under FAS 167, and the risks associated with those assets, in their risk-based capital ratios. However, in order to avoid abrupt adjustments that could undermine or complicate government actions to support the provision of credit to U.S. households and businesses in the current economic environment, the Agencies are providing banking organizations with an optional two-quarter implementation delay followed by an optional two-quarter partial implementation of the effect of FAS 167 on risk-weighted assets and ALLL includable in tier 2 capital. During this rulemaking process, the Agencies have determined that while regulatory capital ratios at banking organizations most effected by implementation of FAS 166 and FAS 167 would decline, those ratios would remain significantly above regulatory minimums subsequent to the implementation of FAS 166 and FAS 167. In addition, the Agencies continue to believe that the new GAAP consolidation standards of FAS 167 more closely align the risk banking organizations face with respect to VIEs with which they are involved than current GAAP standards.\3\ The Agencies are aware, however, that several government programs supporting the securitization market are scheduled to terminate in the first quarter of 2010. In addition, Congress and the regulatory agencies are considering a number of legislative and regulatory changes that would affect the securitization activities. Given that the Agencies cannot precisely assess the combined effect of these changes on the securitization market, and because securitization activities remain an important source of funding for banking organizations, the Agencies are providing banking organizations a delay or phase-in period in the final rule.--------------------------------------------------------------------------- \3\ Determining whether a company is required to consolidate a VIE under FAS 167 depends on a qualitative analysis of whether the company has a ``controlling financial interest'' in the VIE. A company has a controlling financial interest if it has (1) the ability to direct matters that most significantly impact the activities of a VIE and (2) either the obligation to absorb losses of the VIE that could be significant to the VIE, or the right to receive benefits from the VIE that potentially could be significant to the VIE, or both.Q.3. What is the impact of the proposed action by the Office of the Comptroller of the Currency and the Office of Thrift Supervision to end ``no payment'' deferred interest financing promotions on consumers and businesses? I understand the impact to be very large and I would appreciate the agencies working to clarify that ``no payment'' deferred interest financing promotions can be used in the future albeit perhaps with ---------------------------------------------------------------------------revised disclosures and marketing.A.3. In January 2003, the OCC, the Office of Thrift Supervision, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (the Agencies), issued the Credit Card Account Management and Loss Allowance Guidance (AMG). This guidance addressed regulatory concerns with the easing of minimum payment requirements as well as concerns with other account management practices. The AMG states, in part, that the Agencies expect lenders to require minimum payments that will amortize the current balance of the account over a reasonable period. The guidance does not differentiate between general purpose and private label card programs. The receipt of regular monthly payments is important in consumer lending for several reasons. For borrowers, well designed payment structures promote a fundamental understanding of their debt burden in terms of monthly cash-flow and total income. Regular, budgeted payments help avoid the potential pitfalls associated with payment shock when payments begin or significantly increase under the loan amortization schedule. Regular payments also allow borrowers to demonstrate to existing and prospective lenders the willingness and capacity to repay their debts while systematically reducing those debts. For lenders, regular payments are an efficient way to monitor borrowers' willingness and ability to repay without the operational expense associated with requiring ongoing payment capacity information. Regular payment streams also allow the identification of early warning measurements such as delinquencies, roll rates, payment rates, and credit scores to be effective. Furthermore, they help lenders manage Portfolio risk by providing important inputs into the determination of adequate capital and reserve levels. On June 18, 2009, the OCC issued a Supervisory Memorandum to remind our examiners that the increased use of ``No Payment'' programs being offered by banks, and their retail partners, are not consistent with the AMG. We asked our examiners to ensure that national banks cease any ``No Payment'' programs by February 22, 2010. This gives national banks, and their retail partners, time to make necessary changes and coincides with the implementation date for other changes dictated by the Credit CARD Act. As a matter of clarification, the OCC does not object to ``No Interest'' programs. These promotions are very attractive to consumers and often provide real, tangible benefits. However, the OCC believes that any benefits associated with ``No Payment'' programs are outweighed by the negative impacts, including the loss of discipline associated with a regular payment stream, potential payment shock, a prolonged repayment schedule, and bank safety and soundness concerns. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM DANIEL K. TARULLOQ.l. According to a recent New York Times article, about $870 billion, or roughly half of the industry's $1.8 trillion of commercial real estate loans, now sit on the balance sheet of small and medium sized banks. To what extent has TALF encouraged capital to enter the commercial real estate market and what other step should regulators be taking to address this problem?Q.2. How will FASB's new rules on off-balance sheet accounting impact financial institution's ability to lend and how do you intend to implement the changes?A.l.-A.2. At the end of the second quarter of 2009, approximately $3.5 trillion of outstanding debt was associated with commercial real estate (CRE), including loans for multifamily housing developments. Of this amount, $1.7 trillion was held on the books of banks and thrifts, and an additional $900 billion represented collateral for commercial mortgage-backed securities (CMBS), with other investors holding the remaining balance of $900 billion. Before the crisis, securitization markets were an important conduit of credit to the household and business sectors. Securitization markets (other than those for mortgages guaranteed by the government) closed in mid-2008, and the TALF was developed to promote renewed issuance. Under the TALF, eligible investors may borrow to finance purchases of the AAA-rated tranches of various classes of asset-backed securities (ABS). The program originally focused on credit for households and small businesses, including auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. Investors may also use the TALF to purchase both existing and newly issued CMBS, which were included to help mitigate the refinancing problem in that sector. The TALF has been successful in helping restart securitization markets. Issuance has resumed and rate spreads for asset-backed securities have declined substantially. The TALF program has helped finance 2.5 million auto loans, 750,000 student loans, more than 100 million credit card accounts, 480,000 loans to small businesses, and 100,000 loans to larger businesses. Included among those business loans are 4,700 loans to auto dealers to help finance their inventories. Perhaps even more encouraging, a substantial fraction of ABS is now being purchased by investors that do not seek TALF financing, and ABS-issuers have begun to bring non-TALF-eligible deals to market. The TALF program provided financing to investors in the first new CMBS deal, totaling $400 million, since June 2008 on November 16. Significant investor demand drove down the spread on the AAA-rated TALF-eligible portion, with demand for the non-TALF eligible AA and A-rated tranches also higher than anticipated. The strong demand from cash investors and resulting low yield discouraged some TALF investors, resulting in the request for only $72.2 million in TALF loans for the purchase of $85.0 million of the $323.4 million AAA-rated TALF-eligible portion of the deal. However, without the availability of TALF financing, it is unlikely that the deal would have come to market. Since then, we have seen another CMBS deal come to market, totaling $460 million, which did not apply for TALF support. There are reports of a third deal, which would also not apply for TALF financing, totaling $600 million, due to be priced in December. We believe that the demonstration of investor demand for the DDR deal has encourage other lenders to bring similar conservatively underwritten single-borrower deals to market irrespective of the availability of TALF financing. Both non-TALF deals reportedly declined TALF financing in order to structure the securities with terms that are longer than the TALF loans. The Federal Reserve continues to inject liquidity into the commercial real estate market through the TALF program, and is working with market participants to increase transparency and investor protections in this market. We have issued guidance to banks to encourage modifications of maturing CRE loans on properties with sufficient rental income to continue to service the debt payments, but due to the continuing credit crunch are unable to obtain refinancing. And we continue to support broad economic growth that would improve the fundamentals of commercial real estate. As part of the lessons learned process, the President's Working Group on Financial Markets and the Securities and Exchange Commission encouraged the FASB to re-assess its accounting standards for off-balance sheet vehicles. In response, and following a period of public comment on the proposal, FASB recently modified FAS 166 and 167. Under these modifications, an enterprise (e.g., company, individual, or group of bond holders) is required to consolidate certain special purpose entities (SPEs) whenever it has a ``controlling financial interest'' in the SPE, that is, the enterprise has the power to direct the SPE's most significant activities and the right to receive benefits from, or obligation to bear losses of, the SPE. The accounting standards also require disclosure of the enterprise's involvement with such SPEs and any significant changes in risk exposure that result. Whether an enterprise will be required to consolidate an SPE will depend on the specific facts and circumstances of each transaction. Beginning in 2010, many banking organizations that sponsor securitizations will be required to consolidate the associated SPEs. Certain asset-backed commercial paper conduits, revolving securitizations structured as master trusts (such as credit card securitizations), mortgage loan securitizations not guaranteed by the U.S. Government or a U.S. Government-sponsored agency, and term loan securitizations (such as auto and student loan securitizations), are among the types of securitization SPEs that will likely require consolidation by their sponsoring banking organization. In almost all cases, the SPE consolidation requirements will not apply to investors in the asset-backed securities, because such investors generally do not have power to direct the SPE's most significant activities. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER FROM DANIEL K. TARULLOQ.l. Mr. Tarullo, I am concerned about the Federal Reserve overstepping the authority Congress has granted. News reports about the Federal Reserve giving itself the authority to veto pay packages is beyond the pale. LCan you please submit for the record, where in the Federal Reserve Act the Fed [is] given the authority to regulate compensation agreements? LWhy should the Federal Reserve be allowed to veto pay agreements that are approved by a company's board of directors? LHow involved has Chairman Bernanke been in drafting this illegal rulemaking? LWhich Federal Reserve Governor has been pushing the Federal Reserve's policy on this issue?A.l. The Federal Reserve's proposed supervisory guidance and related supervisory initiatives regarding incentive compensation practices derive from our statutory mandate to protect the safety and soundness of the banking organizations we supervise. The proposed guidance was developed in consultation with all Board members and all Board members voted in favor of issuing the proposed guidance for public comment. Recent events have highlighted that improper compensation practices can contribute to safety and soundness problems at financial institutions and to financial instability. Compensation practices were not the sole cause of the crisis, but they certainly were a contributing cause--a fact recognized by 98 percent of the respondents to a 2009 survey conducted by the Institute of International Finance of banking organizations engaged in wholesale banking activities.\1\ The Federal Reserve and the other Federal banking agencies regularly issue supervisory guidance to identify practices that the agencies believe would ordinarily constitute an unsafe or unsound practice, or to identify risk management systems, controls, or other practices that the agencies believe would ordinarily assist banking organizations in ensuring that they operate in a safe and sound manner.--------------------------------------------------------------------------- \1\ See The Institute of International Finance, Inc. (2009), Compensation in Financial Services: Industry Progress and the Agenda for Change (Washington: IIF, March).--------------------------------------------------------------------------- The proposed supervisory guidance, which currently is out for public comment,\2\ is based on three key principles: (1) incentive compensation arrangements at a banking organization should not provide employees incentives to take risks that are beyond the organization's ability to effectively identify and manage; (2) they should be compatible with effective controls and risk management; and (3) they should be supported by strong corporate governance, including active and effective oversight by the organization's board of directors. Consistent with these principles, the Federal Reserve's efforts are focused on ensuring that the way in which banking organizations structure their incentive compensation arrangements do not--intentionally or unintentionally encourage excessive risk-taking, and that banking organization's have the types of policies, procedures, internal controls, and corporate governance structures to promote and maintain sound incentive compensation arrangements.--------------------------------------------------------------------------- \2\ Board of Governors of the Federal Reserve System (2009), ``Federal Reserve Issues Proposed Guidance on Incentive Compensation,'' press release, October 22, 2009.--------------------------------------------------------------------------- Importantly, the proposed guidance does not mandate that banking organizations follow any particular method for achieving appropriately risk-sensitive incentive compensation arrangements. In fact, the guidance expressly recognizes that the methods used to achieve risk-sensitive compensation arrangements likely will differ across and within firms, and that use of a single, formulaic approach is unlikely to consistently promote safety and soundness.Q.2. Is it the Federal Reserve's official position that executive compensation is a cause of systemic risk? LIf so, can you please provide this Committee with documentation to support this position?A.2. Pay practices for risk-taking employees at many levels in banking organizations, not just top executive pay practices, were one among many contributors to the crisis. The role of compensation practices in the crisis has been widely recognized by both industry and supervisors, both here and overseas. For example, in their responses to a survey conducted by the Institute of International Finance, a global association of major financial institutions, 36 of 37 large banking organizations engaged in wholesale activities agreed that compensation practices were a factor underlying the crisis.\3\ The Senior Supervisors Group, which is composed of senior financial supervisors from seven major industrialized countries (the United States, Canada, France, Germany, Japan, Switzerland, and the United Kingdom), also reported that many firms and their supervisors had determined that failures of incentives and controls throughout the industry, including those related to compensation, contributed to systemic vulnerability during the crisis.\4\ Moreover, the Financial Stability Board, a group composed of senior representatives of national financial authorities, international financial institutions, standard setting bodies, and committees of central bank experts, has identified compensation practices as a factor contributing to the crisis.\5\--------------------------------------------------------------------------- \3\ See The Institute of International Finance, Inc. (2009), Compensation in Financial Services: Industry Progress and the Agenda for Change (Washington: IFF, March). \4\ See Senior Supervisors Group (2009), Risk Management Lessons from the Global Banking Crisis of 2008. \5\ See Financial Stability Board (2009), Principles for Sound Incentive Compensation Practices.Q.3. What comments has the Federal Reserve received on this ---------------------------------------------------------------------------proposal from the banks it regulates?A.3. The comment period closed on November 27, 2009. The Board has received 29 comments on the proposed guidance, four of which were submitted on behalf of individual banking organizations, five of which were submitted on behalf of groups representing multiple banking organizations, and two of which were submitted on behalf of groups representing both banking and nonbanking organizations. Public comments on the proposal are made available on the Board's website at http://www.federafreserve.gov/generalinfo/foia/index.cfin?doc_id=OPpercent2D1374&doc_ver=l.Q.4. Mr. Tarullo, regarding the specifics of the proposal: LWould the Federal Reserve require companies to ``clawback'' money that's already been paid to employees? LIs there a threshold a bank must meet to qualify for a review of executive compensation arrangements?A.4. The proposed guidance provides that incentive compensation arrangements should not encourage excessive risk-taking, and describes several methods that are currently used by banking organizations to make compensation more sensitive to risk. These methods can be broadly described as risk adjustment of awards, deferral of payment, longer performance periods, and reduced sensitivity to short-term risk. As noted in the proposed guidance, the deferral of payment method is sometimes referred to in the industry as a ``clawback.'' The term ``clawback'' also may refer specifically to an arrangement under which an employee must return incentive compensation payments previously received by the employee (and not just deferred) if certain risk outcomes occur. Importantly, the proposed guidance does not require a banking organization to use any particular method, including those described in the guidance, to ensure that its incentive compensation arrangements do not encourage employees to take excessive risks. In fact, the proposed guidance expressly recognizes that the methods discussed in the guidance have their own advantages and disadvantages, and that banking organizations will need flexibility in determining how best to achieve balanced incentive compensation arrangements in light of the particular activities, structure, and other characteristics of the organization. The proposed supervisory guidance would apply to all banking organizations that are supervised by the Federal Reserve. These organizations are primarily responsible for ensuring that their incentive compensation arrangements do not encourage excessive risk-taking or pose a threat to the safety and soundness of the organization. To help promote and monitor the development of safe and sound incentive compensation arrangements, the Federal Reserve also has announced two, separate supervisory initiatives. These two separate programs are designed to reflect the differences among the universe of banking organizations supervised by the Federal Reserve. The first initiative involves a special, horizontal review of incentive compensation practices at large, complex banking organizations (LCBOs). LCBOs warrant special supervisory attention because they are significant users of incentive compensation arrangements and because flawed practices at these institutions are more likely to have adverse effects on the broader financial system. A separate program will apply to the thousands of other organizations supervised by the Federal Reserve, including community and regional banking organizations. Supervisory staff will review incentive compensation arrangements at these organizations as part of the regular risk-focused examination process. These reviews, as well as our supervisory expectations for these organizations, will be tailored to reflect the more limited scope and complexity of these organizations' activities--a fact also recognized in various aspects of our guidance. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM DEBORAH K. MATZQ.1. According to a recent New York Times article, about $870 billion, or roughly half of the industry's $1.8 trillion of commercial real estate loans, now sit on the balance sheet of small and medium sized banks. To what extent has TALF encouraged capital to enter the commercial real estate market and what other step should regulators be taking to address this problem?A.2. For the most part, credit unions have not participated in TALF. As cooperatives, many credit unions maintain a whole membership philosophy and seek to retain all of their members' financial business in-house. While federally insured credit unions hold less than 1.5 percent of all commercial real estate loans, the credit union industry's involvement in commercial lending has increased. Loans to members for business purposes have more than quintupled from December 2002 to June 2009, rising from $6.7 billion to $33.7 billion. Of the $33.7 billion member business loan portfolio, 76 percent are secured by real estate. The credit union industry has continued to grant member business loans even when most other financial service providers are contracting. For the first half of 2009, member business loans experienced 11.9 percent growth. NCUA is encouraging the flow of credit in these difficult economic times. Below are some examples of recent actions taken to promote balancing safety and soundness issues with the credit unions' desire to meet their members' financial needs. This month, NCUA hosted a webcast for credit unions and examiners entitled ``Member Business Lending: Regulators' Perspective,'' which provided guidance, best practices, and insight into the underwriting and examination of member business lending. This webcast provided a balanced view of the needs of the industry with safety and soundness considerations. Additionally, NCUA recently released a joint policy statement with the Federal Financial Institutions Examination Council (FFIEC) supporting prudent commercial real estate (CRE) loan workouts. This statement provides guidance for examiners and financial institutions that are working with CRE borrowers who are experiencing diminished operating cash-flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties. This guidance discusses another component of the current lending environment that the financial industry is currently facing. In order to further encourage credit union involvement in commercial lending, Congress could consider raising or removing the current statutory limitation on member business lending. The Federal Credit Union Act currently limits federally insured credit unions to 1.75 times the actual net worth of the credit union or 1.75 times the minimum net worth required for the credit union to be considered well capitalized. Raising or eliminating this limitation on member business loans will increase credit unions' ability to generate and hold more loans to small businesses served by those credit unions, while providing NCUA with the ability and obligation to set standards and benchmarks for this activity based on the needs of the industry. NCUA understands an increase or elimination of this limitation without prudent regulatory oversight could pose significant risk to individual credit unions, and is prepared to provide the necessary oversight. NCUA is also aware of the importance of increasing lending in the commercial real estate market in order to stimulate the economy, while ensuring the safety and soundness of the institutions the NCUA regulates and insures. There is a fine balance between these two objectives that the NCUA is encouraging the credit union industry to find. In fact, a Letter to Credit Unions that promotes best practices of member business lending is currently in process. NCUA will continue to issue guidance to examiners and the credit union industry to address issues related to the current financial and economical environment.Q.2. How will FASB's new rules on off-balance sheet accounting impact financial institution's ability to lend and how do you intend to implement the changes?A.2. The FASB's new rules will make it more difficult for credit unions to sell loans or portions of loans and gain the benefit of removing those assets from their books through sales treatment. For a small number of credit unions who engage in securitization transactions, the new rules will make it difficult to avoid consolidation accounting with the securitization trust. In either case, the net worth ratio will be diluted by the ``transferred'' financial assets that must remain on the credit unions' books even though ``sold''. In the former case, NCUA anticipates that credit unions will restructure legal transfer agreements to conform loans sales and partial loan sales to the ``participating interest'' rules of the new standard and proceed with business as usual. In the latter case, the small number of credit unions that engage in securitization structures will most likely cease and desist from this activity. The larger and more onerous impact of the new accounting rules will fall on the NCUA Board and the Funds it oversees. The NCUA Board oversees the National Credit Union Share Insurance Fund (``NCUSIF''), the Corporate Credit Union Stabilization Fund (``Stabilization Fund''), the Central Liquidity Facility (``CLF''), the NCUA Operating Fund, and the Community Development Revolving Loan Fund. NCUA prepares its financial statement under U.S. generally accepted accounting principles (``GAAP'') for commercial enterprises. As the NCUA Board acts under its statutory authorities to ``workout'' troubled credit unions with the least cost to the NCUSIF and the Stabilization Fund, the new accounting rules will most likely require NCUSIF to consolidate with the Stabilization Fund as well as conserved, troubled credit unions under the NCUA Board oversight. Financial statement consolidation of the NCUSIF, the Stabilization Fund, and troubled, conserved credit unions solely due to the NCUA Board exercising its statutory powers as it acts within its mission under moral obligation to protect credit union and taxpayer resources is not a plausible outcome of applying accounting rules. The new rules assume a ``profit making'' incentive behind NCUA's actions when, in fact, its actions are statutory in nature--supervision and Federal deposit insurance. The primary readers of the NCUSIF financial statements--credit union members, the public, and the U.S. Treasury Department--are not better served by the consolidated presentation of governmental with non-governmental entities. A scope exception for government entities from consolidating with the entities it supervises and insures would be the optimal outcome. The FASB has not been receptive to such a scope exception primarily because it would not have wide applicability and there is an existing scope exception within the standard for non-profit entities. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM TIMOTHY WARDQ.1. According to a recent New York Times article, about $870 billion, or roughly half of the industry's $1.8 trillion of commercial real estate loans, now sit on the balance sheet of small- and medium-sized banks. To what extent has TALF encouraged capital to enter the commercial real estate market and what other step should regulators be taking to address this problem?A.1. The Term Asset-Backed Securities Loan Facility (TALF) program was primarily created to help restore liquidity in the asset-backed securities markets. Since the Federal Reserve Board (the FRB) announced an expansion of the TALF to include commercial mortgage-backed securities (CMBS), the Federal Reserve Bank of New York (FRBNY) has received loan requests totaling $6.5 billion to help fund the purchase of legacy CMBS (those created prior to January 1, 2009). Improvements in CMBS market liquidity and confidence have occurred since the severe dislocations in these markets during late summer/early fall of 2008. Most notably, the yield spreads between CMBS and 10-year Treasury securities have narrowed significantly from over 10 percent in late summer/early fall 2008 to about 4.5 percent in November 2009. Though still wider than typical spreads of about 1.5 percent, the narrowing of spreads is evidence of normalization of the CMBS markets. And it is likely the TALF program contributed to these improvements. It is important to note that only a small percentage of commercial real estate loans are in CMBS. According to estimates from the Commercial Mortgage Securities Association, only about 25 percent of total commercial real estate loans are held in CMBS. This may point to the need to expand TALF, or similar programs, beyond the CMBS markets to help address rising problems in commercial real estate. And this is especially true for small- and medium-sized banks and thrifts.Q.2. How will FASB's new rules on off-balance sheet accounting impact financial institution's ability to lend and how do you intend to implement the changes?A.2. As a result of the FASB accounting changes, generally effective the beginning of 2010 for most institutions, many securitizations previously off-balance sheet will come on-balance sheet and many new securitizations will stay on-balance sheet. Consequently, higher regulatory capital requirements will result from the larger balance sheets and some institutions may need to raise additional capital or shrink their balance sheet size, which could result in a downward pressure on lending activity and increase the costs of borrowing. The Federal banking agencies require that regulatory reports comply with Generally Accepted Accounting Principles (GAAP). By law, reports filed with the Federal banking agencies must be uniform and consistent with and no less stringent than GAAP (as required by Section 37 of the FDI Act). Consequently, securitization accounting must be reported by financial institutions in accordance with GAAP. GAAP serves as the starting point for regulatory capital treatment. Due to these GAAP accounting changes, an Interagency Notice of Proposed Rulemaking (NPR) for the regulatory capital treatment of securitizations was issued. The comment period for the NPR closed on October 15, 2009. The NPR proposed to follow the new GAAP treatment for regulatory capital purposes as, unless determined otherwise based upon information provided through the comment process, the agencies believe the new GAAP more appropriately reflects the securitization risks to which financial institutions are exposed. The comments are currently being evaluated by the banking agencies with the expectation of issuing a final rule before the regulatory reporting of these accounting changes.Q.3. What is the impact of the proposed action by the Office of the Comptroller of the Currency and the Office of Thrift Supervision to end ``no payment'' deferred interest financing promotions on consumers and businesses? I understand the impact to be very large and I would appreciate the agencies working to clarify that ``no payment'' deferred interest financing promotions can be used in the future albeit perhaps with revised disclosures and marketing.A.3. Over the past year, OTS and OCC have worked closely to develop their respective policy statements, which are substantially identical. On September 24, 2009, OTS issued CEO Letter 321--``No Interest, No Payment'' Credit Card Programs to remind savings associations of certain requirements contained in the 2003 interagency ``Account Management and Loss Allowance Guidance for Credit Card Lending.'' That guidance articulated sound account management, risk management, and loss allowance practices for all institutions engaged in credit card lending. CEO Letter 321 reminds savings associations of OTS's longstanding position that minimum monthly payments are a key tenet of safe and sound retail lending and should be required on credit card accounts. It states that regular monthly payments add structure and discipline to the lending arrangement, provide regular and ongoing contact with the borrower, and allow the borrower to demonstrate and the bank to assess continued willingness and ability to repay the obligation over time. Conversely, the absence of a regular payment stream may result in protracted repayment and mask true portfolio performance and quality. Further, in accordance with the OTS Examination Handbook, it indicates that the minimum monthly payment should cover at least a 1-percent principal reduction plus all assessed monthly interest and finance charges. CEO Letter 321 neither prohibits nor discourages the practice of ``no interest'' credit card promotions. Finally, the CEO Letter states that savings associations will be given a reasonable time to implement any changes to their existing programs as a result of the policy clarification. All savings associations are expected to be in full compliance for all new credit card transactions no later than February 22, 2010. OTS has no precise data on the expected impact of the OTS and OCC ending the no payment programs offered by banks and savings associations. Because of the increased delinquencies associated with certain customers of no-pay accounts, we expect a decline in loan delinquencies and chargeoffs. While there may be a curtailment in the number of purchases that these programs facilitate, OTS believes that the primary affect will be for borrowers who cannot afford the purchases. In arriving at the decision to issue a letter on these programs, OTS considered, among other things, that recent examinations of OTS-supervised savings associations that offer ``no interest, no payment'' credit card programs revealed increasing past due and losses related to these accounts. OTS examination staff noted that: No payment promotions present substantially higher credit risk (unexpected loss) to banks than regular revolving accounts. This is not necessarily because the accounts/customers themselves are riskier; but because the structure of the promotion results in an inability to adequately monitor and assess risk. These promotions also present problems for customers who are less adept at managing their finances. The best way to address these problems is to require some level of minimum monthly payments. No payment promotions are most prevalent on big ticket purchases such as furniture, or big screen televisions. These types of purchases often result in balances of $5,000 or more. Many view promotional programs that offer no payments until next year as being designed to entice customers into making a large purchase that they may not otherwise have considered or thought they couldn't afford. It allows customers to acquire these items without worrying about paying for them for a long period of time. For those customers who are not as adept at managing their finances, it may be very difficult to make a $5,000 payment at the end of the promotion--at which time they will incur high financing costs, in some cases (back-billing) all of the costs they thought they were avoiding.RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JOSEPH A. SMITHQ.1. According to a recent New York Times article, about $870 billion, or roughly half of the industry's $1.8 trillion of commercial real estate loans, now sit on the balance sheet of small and medium sized banks. To what extent has TALF encouraged capital to enter the commercial real estate market and what other step should regulators be taking to address this problem?A.1. Did not respond by printing deadline.Q.2. How will FASB's new rules on off-balance sheet accounting impact financial institution's ability to lend and how do you intend to implement the changes?A.2. Did not respond by printing deadline. ------ RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM THOMAS J. CANDONQ.1. According to a recent New York Times article, about $870 billion, or roughly half of the industry's $1.8 trillion of commercial real estate loans, now sit on the balance sheet of small and medium sized banks. To what extent has TALF encouraged capital to enter the commercial real estate market and what other step should regulators be taking to address this problem?A.1. The financial institutions supervised by NASCUS members--state-chartered credit unions--do not have access to TALF.Q.2. How will FASB's new rules on off-balance sheet accounting impact financial institution's ability to lend and how do you intend to implement the changes?A.2. State-chartered credit unions have not made substantive use of the new FASB provisions related to off-balance sheet accounting and accordingly, it is not anticipated that these changes by FASB will have a material impact on the ability of credit unions to lend to their members. Credit unions will be minimally impacted, if at all. The two areas of primary structural constraint regarding credit union lending continue to be field of membership restrictions and the limitations imposed by Federal restrictions on member business lending. FASB's new rules regarding off-balance sheet accounting are likely to have a more substantial impact on large commercial banks which may have utilized off-balance sheet structures to mitigate on-balance sheet risk." CHRG-111shrg57319--6 Mr. Cathcart," Chairman Levin, Ranking Member Coburn, and Members of the Committee, thank you for the opportunity to comment on my history with Washington Mutual Bank and to provide a risk management perspective on some root causes of the U.S. financial services crisis.--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Cathcart appears in the Appendix on page 138.--------------------------------------------------------------------------- Before leading the Enterprise Risk Management Group at WaMu, I spent more than 20 years working in risk management positions at World Bank of Canada, Bank One, and CIBC. I joined WaMu's management team in December 2005 and served as the Chief Enterprise Risk Officer through April 2008. When I arrived at WaMu, I inherited a Risk Department that was isolated from the rest of the bank and was struggling to be effective at a time when the mortgage industry was experiencing unprecedented demand for residential mortgage assets. I understood that the regulatory agencies and WaMu's Board of Directors were interested in expanding risk management functions within the company to meet this demand. The general function of risk management is to measure, monitor, and establish parameters to control risk so that the company is prepared for potential loss. In order to meet this objective, during my first few months, I reorganized the department in order to align risk management with the company's business lines and to embed risk managers in each of the four business units. The company's strategic plan to shift its portfolios towards higher margin products was already underway when I arrived at WaMu. Basically, this strategy involved moving away from traditional mortgage lending into alternative lending programs involving adjustable-rate mortgages as well as into subprime products. The strategic shift to higher-margin products resulted in the bank taking on a higher degree of credit risk because there was a greater chance that borrowers would default. In hindsight, the shift to both adjustable-rate Option ARM loans and subprime products was a significant factor in the failure of WaMu and contributed to the financial crisis generally. These products depended on house price appreciation to be viable. When housing prices decelerated, they became problem assets. In early 2006, a high volume of Option ARM loans was being originated and securitized at WaMu and throughout the West Coast mortgage industry. Wall Street had a huge appetite for Option ARMs and WaMu could sell these loans as quickly as it could originate them. With an incentive to bundle and sell large quantities of loans as quickly as possible, banks all over the country, including WaMu, became conduits for the securitization and sale of loans to Wall Street. The banking industry began to move away from the traditional model, where banks held the loans they originated, towards a new model where banks acted as conduits. The demand for securitized mortgage products encouraged poor underwriting, and guidelines which had been established to mitigate and control risk were often ignored. The source of repayment for each mortgage shifted away from the individual and their credit profile to the value of the home. This approach of focusing on the asset rather than on the customer ignores the reality that portfolio performance is ultimately determined by customer selection and credit evaluation. Even the most rigorous efforts to measure, monitor, and control risk cannot overcome poor product design and weak underwriting and organizational practices. Another key component of WaMu's higher-risk strategy involved efforts to increase the company's exposure to the subprime market. These efforts focused on lending to customers who did not meet the credit qualifications to obtain traditional mortgages. In order to be successful, any bank offering subprime products must operate with a high degree of credit discipline. However, the credit performance of Long Beach-originated loans did not meet acceptable risk standards and the high level of early payment defaults suggested poor customer selection and underwriting practices. Risk management, therefore, determined that Long Beach had outsized risk parameters and we implemented standards to tighten them. In the end, WaMu's subprime exposure never reached the levels envisaged in the 2005 strategy. In fact, thanks in part to tightening of controls and risk parameters, these were reduced. Financial conditions in late 2007 and early 2008 deteriorated further in 2007 and 2008. As head of risk, I began to be excluded from key management decisions. By February 2008, I had been so fully isolated that I initiated a meeting with the director, where I advised that I was being marginalized by senior management to the point that I was no longer able to discharge my responsibilities as Chief Enterprise Risk Officer of WaMu. Within several weeks, I was terminated by the chairman. In conclusion, let me identify some of the factors which contributed to the decline of the U.S. financial market. A confluence of factors came together to create unprecedented financial conditions which the market was not equipped to handle. Due to a lack of regulation and lax lending standards, mortgage brokers operated without oversight and underwriting quality suffered as a result. The banking industry's focus shifted from customer selection to asset-based lending as banks became conduits for Wall Street, which could and would securitize whatever mortgage pool the bank originated. Rating agencies and regulators seemed to be lulled into a sense of complacency, and the Government-Sponsored Enterprises opened their risk envelopes and guaranteed and warehoused increasingly risky products. Thank you for the opportunity to share my thoughts and experiences. I look forward to the Subcommittee's review of this matter and I am prepared to answer any questions. Senator Levin. Thank you very much, Mr. Cathcart. We thank you all for your statements, which we have had an opportunity to read. " Mr. Melby,"TESTIMONY OF RANDY MELBY,\1\ FORMER GENERAL AUDITOR, WASHINGTON FOMC20080724confcall--73 71,MR. KROSZNER.," I just want to underscore the points that President Yellen made because extending the term or even just having the term with the TAF really creates a bit more of a burden for us to think about not just primary versus secondary credit but effectively three modes. One is sort of a superprimary credit, where you can borrow at term and now term of 84 days rather than 28 days. This issue came up not only in the San Francisco District but also, as Sandy Pianalto well knows, in the Cleveland District. Then there are the overnight primary credit and the secondary credit. We have to think about how we will apply this in a consistent way throughout the System. Also, although in principle we can pull back exactly as you described, as Janet argued, that can be very dangerous to do. Also, if we do that, sometimes it may have to be revealed publicly on a form 8-K. If there is a significant change in an institution's liquidity situation and if an institution is in a difficult circumstance, the institution has often made reports publicly about how much liquidity it has. If there is a significant change in our willingness to provide institutions with credit, they may have to report that, and that could be a precipitating event, which puts us in a difficult situation. So I think we just need to think very carefully about the criteria that we will use for eligibility for long-term borrowing versus overnight borrowing and primary versus secondary borrowing and then not kid ourselves that we may have more options than we think to pull back because it may be very, very difficult to pull back. Obviously, we also have pressure from the FDIC and other regulators not to be the precipitating event. " CHRG-109shrg21981--203 PREPARED STATEMENT OF SENATOR WAYNE ALLARD Thank you, Chairman Greenspan for coming to the Senate today to share the Federal Reserve's Semi-Annual Monetary Policy Report to the Congress. This Committee and the Congress greatly benefit from your reports and visits, and the expertise that you offer to us and the Country. The economy is healthy and expanding, with GDP having increased in both the third and fourth quarters of 2004. Productivity and output both increased as well during the last months of 2004. We have even seen recent increases in exports and a decrease in the U.S. current account deficit. The Federal Reserve Board has done a good job at monitoring monetary policy and economic indicators in order to see that policy remains accommodative to the ebbs and flows of the U.S. economy. Their steadfastness in recognizing the immediate monetary needs and adjusting policy accordingly is to be commended. Dr. Greenspan, I appreciate your commitment to this Committee, the Congress, and this country. I look forward to hearing your evaluation and insights on monetary policy, the condition of the economy, and your forecast for the next several months. Thank you, Chairman Greenspan for coming to the Senate today to share the Federal Reserve's Semi-Annual Monetary Policy Report to the Congress. This Committee and the Congress greatly benefit from your reports and visits, and the expertise that you offer to us and the Country. The economy is healthy and expanding, with GDP having increased in both the third and fourth quarters of 2004. Productivity and output both increased! as well during the last months of 2004. We have even seen recent increases in exports and a decrease in the U.S. current account deficit. The Federal Reserve Board has done a good job at monitoring monetary policy and economic indicators in order to see that policy remains accommodative to the ebbs and flows of the U.S. economy. Their steadfastness in recognizing the immediate monetary needs and adjusting policy accordingly is to be commended. Dr. Greenspan, I appreciate your commitment to this Committee, the Congress, and this country. I look forward to hearing your evaluation and insights on monetary policy, the condition of the economy, and your forecast for the next several months. ---------- CHRG-111hhrg58044--47 Mr. Wilson," It will show up on the credit report. " FOMC20070131meeting--316 314,MS. DANKER.," I’ll read the directive from page 25 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining the federal funds rate at an average of around 5¼ percent.” The risk assessment: “The Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” Chairman Bernanke Yes Vice Chairman Geithner Yes Governor Bies Yes President Hoenig Yes Governor Kohn Yes Governor Kroszner Yes President Minehan Yes Governor Mishkin Yes President Moskow Yes President Poole Yes Governor Warsh Yes" FOMC20071206confcall--14 12,MR. MADIGAN.," Thanks, Spence. The staff recognizes that weighing the advantages and disadvantages of the various options is difficult. Choice of any of these options—or none—might be reasonable in the circumstances. Still, we believe that, for the reasons we have discussed, the adoption of a temporary TAF and the establishment of a swap line with the ECB at this time are warranted. As Bill discussed, conditions in term money markets have been deteriorating, and those strains are focused particularly on year-end. It seems likely that the proposed measures could be helpful in providing assurance to banks that funding will be available over year-end and could reduce the odds of gradual further deterioration or a sudden worsening of money market conditions. Should the Board and the FOMC approve these proposals, the Federal Reserve could announce them Wednesday morning in coordination with the foreign central banks that may be taking related actions. The coordinated announcements would help maximize the benefit of these measures. That concludes our prepared remarks." FOMC20060510meeting--104 102,MS. MINEHAN.," Thank you very much, Mr. Chairman. Current economic conditions are fair to good in New England. Consumers report rising confidence, at least in the current situation. Manufacturers report solid domestic and international demand. Business confidence is also good relative to the current situation. Unemployment claims and online job postings suggest continuing positive employment momentum. Northern-tier tourism was hurt by lackluster winter weather, but reportedly tourism in Boston has been quite strong. And even with the poor winter season, tax revenues have grown considerably above budget in all but Rhode Island. On the not-so-hot side, residential real estate markets apparently have slowed, particularly at the high end, with rising inventories of unsold expensive homes. Reportedly, however, more moderately priced homes continue to sell, though transaction volumes for the region as a whole are trailing off. Average selling prices for single-family homes continue to increase according to conventional home price indexes, the last ones of which we had for the final quarter of last year. More-recent anecdotes also suggest that they have been increasing. However, the rates of increase are down to single digits. To some contacts, the market, though slower, seems healthier and more realistic. From a wide range of contacts I have spoken with since the last meeting, I want to highlight three concerns. First, rising costs for energy, transportation, and raw materials are pushing price increases. These are more likely to be tolerated by customers than in the recent past. And firms that say they are unable to pass on such increases report that they expect considerable bottom-line deterioration as a result. Second, skilled labor across a wide range of industries is harder to find and expensive, though planned overall wage increases do not seem to be larger than a year ago. So there is some issue here of skilled labor versus unskilled labor differentials. Finally, there is a general worry, despite pretty good current economic conditions, that energy and energy-related costs will eat into consumer demand and, combined with the flattening in housing markets, will affect growth prospects. Now, on the national scene, our forecast is just about the same as the Greenbook’s. Growth slows for the rest of this year to next and in ’07 is slightly below potential. Unemployment rises slightly, even with continued pretty good job growth. Inflation first rises and then falls. It’s the same general forecast we’ve had for a while. But the question is where the risks to this forecast are. To me they seem to have risen, perhaps on both sides, but I’d say they’re a bit tilted to higher price growth. Q1 growth was clearly above expectations. Some of this was frontloaded into January. April employment was on the slow side; there is some evidence of slowing in housing markets, though prices continue to rise; and household wealth, including stock market wealth, is rising as well. The longer end of the yield curve has turned up, tightening financial conditions somewhat, though corporate profits remain strong and credit spreads remain narrow. It’s possible we’re seeing consumer spending slow, but business spending has strengthened. Thus, while the best guess is that the trajectory for growth is downward, how much and how fast remains uncertain and is a part more of the forecast than of the current picture. On the other hand, although incoming core inflation data have tracked only a bit above what we had expected, I’m not comfortable with what might be called the inflation atmosphere. With inflation compensation and inflation expectations rising, the dollar falling, and gasoline prices around $3 a gallon, it seems to me that inflation risks really have tilted somewhat. I know that each of these may turn out to be transitory. It’s also true that, as yet, indications of wage pressures have been mixed, and while productivity growth has been trending lower, it remains quite healthy. The global competition that characterized much of the past ten years remains healthy, and profit margins are wide enough on average to absorb the rising input costs related to a growing world. Still, anticipating core PCE price growth at 2½ percent, as the Greenbook does for this quarter, makes me at least pause. Given the six-month and the three-month rates of growth in core PCE, a slowing in rates of price growth, while expected, still is only part of the forecast. In sum, although the forecast is rosy—perhaps a bit too rosy—risks to the realization of that forecast appear to have risen. Some of these may be on the downside, but we are also at a point where estimating the economy’s remaining capacity is difficult, and the atmosphere of the inflation picture has changed. So though I don’t want to overreact or be accused of doing so, I am less sure than I was at our last meeting about both where we are and where we need to be." CHRG-111hhrg58044--2 Chairman Gutierrez," This hearing of the Subcommittee on Financial Institutions and Consumer Credit will come to order. Good morning and thanks to all of the witnesses for agreeing to appear before the subcommittee today. Today's hearing will examine the impact that the use of credit reports and information has on consumers outside of the traditional use for lending and credit purposes. We will examine the use of credit-based insurance scores, where the medical debt is predictive of a person's chances of defaulting, and finally, whether or not a consumer's credit information should be used to determine their employability. We will be limiting opening statements to 10 minutes per side, but without objection, all members' opening statements will be made a part of the record. We may have members who wish to attend but do not sit on the subcommittee. As they join us, I will offer an unanimous consent motion for each to sit with the subcommittee and for them to ask questions when time allows. I yield myself 5 minutes for my opening statement. This morning's hearing is about the use of credit information in areas such as insurance underwriting and employment purposes. We will hear about important yet complex and often opaque processes concerning credit board insurance and insurance scores in the first panel. In the second panel, we will hear about issues that are equally important to a vast number of consumers--the little known or understood use of credit information for hiring and even firing decisions, and the effect medical debt has on one's consumer report, even after you paid the medical debt off. When legislators or regulators attempt to fully grasp an issue such as credit-based insurance scores, they see a complex system laden with ever-changing computer applications and models, but it is precisely this complexity that should make us here in Congress delve further into an issue that affects every single American who owns or rents a house, a car, has insurance, has a job or is looking for a job, or is likely to incur medical debt. Do most consumers know that their car or homeowner's insurance rates may go up due to their credit score? Do they know that if one of their medical bills goes to a collection agency and they pay it in full and settle it, it will still affect their credit report for up to 7 years? Do people realize that even in these tough economic times, pre-employment consumer credit checks are increasingly widespread, trapping many people in the cycle of debt that makes it harder for them to pay off their debts and harder for them to get the job that would allow them to pay off the debt? I wonder--when you go to State Farm or Allstate or GEICO to get your insurance and they have a credit score, and that credit score was negative, so they are going to charge you more for your insurance, do they send you a note in the mail telling you that you are going to pay more for that insurance? I think these are all very important questions that the American public should know. Indeed, the current system facilitates the denial of employment to those who have bad debt, even though bad debt oftentimes results from the denial of employment, a vicious cycle. You cannot get a job, so you get a bad credit score. You have a bad credit score, so you cannot get a job. I wonder who is most likely to be affected, especially in these economic times. What? Extend unemployment compensation? What about the national debt? I have a way maybe we could settle unemployment compensation, how about letting somebody get a job and prove who they are without some mysterious number coming out of a black box somewhere where nobody knows about it. That is why the subcommittee is holding this hearing, the second so far this year on the issue of credit reports, credit scores, and their impact on consumers. We will look at reports and studies about the predictive nature of insurance scores and traditional scores among other things. As we do so, we also need to look at the basic guiding principles of equity, fairness and transparency. Some have contended that there is no disparate treatment of minorities in credit-based insurance scores. Some will say that even if there is a disparate impact on some groups, the system still does not need to be changed. The question of how predictive a credit-based insurance score is on an insured's likelihood to file a claim is important, as it is the predictive value of traditional credit scores used for credit granting. As long as there continue to be disparities in the outcomes of the current system for racial and ethnic groups and along class and geographical lines, I believe the system needs strenuous oversight and may need fundamental change. How to correct the disparities in the system with this disproportionately negative impact on minorities and low-income groups while maintaining the core framework of credit information as a risk management tool is a challenge we should take on. For example, on issues like the use of credit information for developing insurance pricing and the inclusion of medical debt collection in determining a consumer's risk of default, I have doubts as to whether there are biased uses of data. The Equal Employment Opportunity Commission, the Federal Reserve, the Brookings Institution, the Federal Trade Commission, and the Texas Department of Insurance have all found that racial disparities between African Americans, Latinos and Whites in credit scores exist, and we will see this has wide ranging implications beyond simply obtaining consumer credit. Defending a system where decisions such as determining car insurance rates or even something as vital as to whether or not to hire someone is based on something that has shown to possess a degree of bias is difficult, to say the least. I welcome the testimony this morning of those who believe the system works, and of those who believe the system needs to be changed to work in a more equitable, fair, and transparent fashion. In the same spirit of transparency, I am making it clear at the outset that I side with the latter group. I do not think you need any sort of score to predict that, from my point of view. In order to persuade this committee not to move forward on legislation that would strongly limit what we believe to be unfair practices, the industry witnesses before us must prove to me that not only are the practices we call into question scientifically predictive, but more importantly, they are fair and equitable to all Americans. The ranking member, Mr. Hensarling, is recognized. " FOMC20060328meeting--268 266,MS. DANKER.," I will read the directive wording from page 25 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 4¾ percent.” And now the risk assessment from the statement that was just handed out: “The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.” Chairman Bernanke Yes Vice Chairman Geithner Yes Governor Bies Yes President Guynn Yes Governor Kohn Yes Governor Kroszner Yes President Lacker Yes Governor Olson Yes President Pianalto Yes Governor Warsh Yes President Yellen Yes" FOMC20071031meeting--173 171,MS. YELLEN.," Thank you, Mr. Chairman. I found the choice between alternatives A and B to be a tough call. I’ve struggled with this over the past week, and in the end I find the arguments for alternative A for a 25 basis point rate cut more persuasive. I have several reasons for this judgment. First, as I argued yesterday, further action to my mind is appropriate, even leaving aside the recent financial shock. With output near potential and inflation near my objective, the stance of policy should be close to neutral, and while we can debate exactly what the equilibrium real interest rate is—that’s an important discussion to me—it appears that, even after our action in September, policy is somewhat restrictive. I agree with President Plosser’s view that we need to maintain some consistency in our thinking over time, and I would say that I expressed this identical view at our last meeting and said at that time that I did envision a 75 basis point cut during 2007. So my views haven’t changed, and the data that we have seen in the intermeeting period haven’t suddenly pushed me in the direction of this move—instead, if anything, slightly away from it, but I regard those data as largely uninformative. So my views really haven’t changed about this, but it seems to me that the argument that we should be moving toward neutral does allow for quite a bit of flexibility in the timing of an additional rate cut. It doesn’t have to be something that we do in October. We could do it in December, or it could wait until January. So that argument in and of itself doesn’t completely persuade me that we have to do it today. But I do think it would be prudent to act today for a couple of reasons. The first has to do with the effects of the financial shock of the summer. When we came into the meeting last month, we faced credit conditions that were quite restrictive, and our goal was to offset that shock to avoid a significant economic slowdown. I think the favorable inflation results over the previous six months did give us the flexibility to take strong action, which we did. My judgment is that we have had some success so far. Financial conditions appear to be easier than they were in September, and arguably, as I said yesterday, I think we may have roughly neutralized the shock. But an important element in our success has been the decline in Treasury rates along with the further decline we’ve seen in the dollar and the increase in equity prices since we last met. Those changes are supported by the market’s expectations that we will ease further at this meeting and beyond. In other words, if we don’t ease today as the market expects, then rates may move up, and that raises concern to my mind about whether we will have accomplished the goal of offsetting the restrictive effects of the recent financial shock. A second reason for easing today is the asymmetric nature of the risks we face in achieving our goals. I do see some upside risk to inflation although I have not read the recent increase in five-to-ten-year inflation compensation as really reflecting a market perception of a deterioration in long-term inflation expectations. In my view, the more serious risk is the one that our Chairman discussed yesterday of unleashing negative nonlinear dynamics in the real and financial economy that could be difficult to reverse. Conditions in housing markets and their possible implications for housing prices and, in turn, consumption are at the center of these concerns. In addition, although liquidity in financial markets has improved, I think the markets are still rather fragile and subject to further sudden disruptions. I’m comfortable with the wording in alternative A, including the balance of risk assessment. Through the fed funds rate being 25 basis points lower, I do see the upside risk to inflation as being roughly balanced with the downside risk to growth. I think the statement does give us sufficient flexibility to respond in whatever way we need to, and that includes the possibility of taking back some of this easing should there be upside surprises. I do think that it’s important to signal to markets that this is not yet another step in a planned series of continuing rate cuts." CHRG-110shrg50420--86 Mr. Dodaro," Not to my knowledge. Senator Menendez. Let me ask you, among the conditions that we should be looking at, first in line and the oversight board at the appropriate time, should the Congress not be considering what, in fact, that oversight board should be demanding of the Big Three? For example, all of these companies have presented some restructuring plans, but ensuring that that restructuring takes place, ensuring that there are benchmarks and that there are timeframes for those benchmarks, should that not be a critical part of what we are seeking? " CHRG-111shrg52619--210 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM GEORGE REYNOLDSQ.1. Consumer Protection Regulation--Some have advocated that consumer protection and prudential supervision should be divorced, and that a separate consumer protection regulation regime should be created. They state that one source of the financial crisis emanated from the lack of consumer protection in the underwriting of loans in the originate-to-distribute space. What are the merits of maintaining it in the same agency? Alternatively, what is the best argument each of you can make for a new consumer protection agency?A.1. A separate consumer protection regulation regime would not recognize state law. State legislators and regulators are in the first and best position to identify trends and abusive practices. One regulator for consumer protection eliminates the dual oversight that is made possible by state and federal laws and regulations. It would also inhibit coordination and cooperation between regulators or worse, provide a gap in regulation and oversight by the state regulatory system. The Treasury Blueprint for a Modernized Financial Regulatory Structure, presented in March 2008, suggests the creation of a business conduct regulator to conduct regulation across all types of financial firms. The business conduct regulator would include key aspects of consumer protection, including rule writing for disclosures and business practices. This structure proposes to eliminate gaps in oversight and provide effective consumer and investor protections. The proposed business conduct regulator at the federal level would be separate and distinct from the suggested prudential regulator. NASCUS \1\ believes such a system would curtail, not enhance, consumer protections.--------------------------------------------------------------------------- \1\ NASCUS is the professional association of state credit union regulatory agencies that charter, examine and supervise the nation's 3,100 state-chartered credit unions. The NASCUS , mission is to enhance state credit union supervision and advocate for a safe and sound credit union system.--------------------------------------------------------------------------- The Treasury Blueprint would create a new federal bureaucracy, taking away most supervisory, enforcement and rule making authority from the states and federalizing those authorities in a new business conduct regulator. Much of the focus of attention of the OCC, OTS and NCUA has been on seeking preemption from state consumer protection laws. An example of this is the preemption efforts undertaken by these agencies regarding the Georgia Fair Lending Act (GFLA). It is vital that consumer protection statutes adopted at the state level apply consistently to all financial institutions regardless of charter type.Q.2. Regulatory Gaps or Omissions--During a recent hearing, the Committee has heard about massive regulatory gaps in the system. These gaps allowed unscrupulous actors like AIG to exploit the lack of regulatory oversight. Some of the counterparties that AIG did business with were institutions under your supervision. Why didn't your risk management oversight of the AIG counterparties trigger further regulatory scrutiny? Was there a flawed assumption that AIG was adequately regulated, and therefore no further scrutiny was necessary?A.2. NASCUS members do not have regulatory oversight of AIG. The answers provided by NASCUS focus on issues related to our expertise regulating state credit unions and issues concerning the state credit union system.Q.3. Was there dialogue between the banking regulators and the state insurance regulators? What about the SEC?A.3. This question does not apply to state credit union regulators. The answers provided by NASCUS focus on issues related to our expertise regulating state credit unions and issues concerning the state credit union system.Q.4. If the credit default swap contracts at the heart of this problem had been traded on an exchange or cleared through a clearinghouse, with requirement for collateral and margin payments, what additional information would have been available? How would you have used it?A.4. Credit unions did not and currently do not engage in credit default swap contracts to the best of our knowledge.Q.5. Liquidity Management--A problem confronting many financial institutions currently experiencing distress is the need to roll-over short-term sources of funding. Essentially these banks are facing a shortage of liquidity. I believe this difficulty is inherent in any system that funds long-term assets, such as mortgages, with short-term funds. Basically the harm from a decline in liquidity is amplified by a bank's level of ``maturity-mismatch.'' I would like to ask each of the witnesses, should regulators try to minimize the level of a bank's maturity-mismatch? And if so, what tools would a bank regulator use to do so?A.5. Most credit unions supervised by state regulators have strong core liquidity funding in the form of member deposits. Unlike other financial institutions which use brokered funding, Internet deposit funding and other noncore funding, these practices are rare in credit unions. Many credit unions' liquidity position would be favorably impacted if they had access to supplemental capital. Supplemental capital would bolster the safety and soundness of credit unions and provide further stability in this unpredictable market. It would also provide an additional layer of protection to the NCUSIF thereby maintaining credit unions' independence from the federal government and taxpayers. Credit union access to supplemental capital is more important than ever given the impact of losses in the corporate system on federally insured natural-person credit unions. Stabilizing the corporate credit union system requires natural-person federally insured credit unions to write off their existing one percent deposit in the NCUSIF, as well as an assessment of a premium to return NCUSIF's equity ratio to 1.3 percent. Additionally, credit unions with capital investments in the retail corporate credit union could be forced to write-down as much as another $2 billion in corporate capital. This will impact the bottom line of many credit unions, and supplemental capital could have helped their financial position in addressing this issue. State regulators are committed to taking every feasible step to protect credit union safety and safety and soundness--we must afford the nation's credit unions with the opportunity to protect and grow liquidity as well as the tools to react to unusual market conditions. The NASCUS Board of Directors and NASCUS state regulators urge you to enact legislation allowing supplemental capital.Q.6. Too-Big-To-Fail--Chairman Bair stated in her written testimony that ``the most important challenge is to find ways to impose greater market discipline on systemically important institutions. The solution must involve, first and foremost, a legal mechanism for the orderly resolution of those institutions similar to that which exists for FDIC-insured banks. In short we need to end too big to fail.'' I would agree that we need to address the too-big-to-fail issue, both for banks and other financial institutions. Could each of you tell us whether putting a new resolution regime in place would address this issue?A.6. While relatively few credit unions fall into the category of ``too big to fail,'' with the exception perhaps of some of the larger corporate credit unions, I believe as a general rule that if an institution is too big to fail, then perhaps it is also too large to exist. Perhaps the answer is to functionally separate and decouple the risk areas of a ``too big to fail'' organization so that a component area can have the market discipline of potential failure, without impairing the entire organization. Financial institutions backed by federal deposit insurance need to have increased expectations of risk control and risk management.Q.7. How would we be able to convince the market that these systemically important institutions would not be protected by taxpayer resources as they had been in the past?A.7. Again this area has relatively little application to state-chartered credit unions. But the most effective message can be conveyed to the marketplace by clearly indicating that these riskier decoupled operations will not be supported by taxpayer resources and then following through by letting these entities enter bankruptcy or fail without government intervention.Q.8. Pro-Cyclicality--I have some concerns about the pro-cyclical nature of our present system of accounting and bank capital regulation. Some commentators have endorsed a concept requiring banks to hold more capital when good conditions prevail, and then allow banks to temporarily hold less capital in order not to restrict access to credit during a downturn. Advocates of this system believe that counter-cyclical policies could reduce imbalances within financial markets and smooth the credit cycle itself. What do you see as the costs and benefits of adopting a more counter-cyclical system of regulation? Do you see any circumstances under which your agencies would take a position on the merits of counter-cyclical regulatory policy?A.8. Perhaps the most needed measure relative to a counter-cyclical system of regulation is the need to increase deposit insurance premiums during periods of heightened earnings, as opposed to the current practice of basing these assessment on deposit insurance losses. Financial institutions end up with high assessments typically at the same time that their capital and earnings are under pressure due to asset quality concerns. The deposit insurance funds need to be built up during the good times and banks and credit unions need to be able to have lower assessments during periods of economic uncertainty. It would also be wise to review examination processes to see where greater emphasis can be placed on developing counter-cyclical processes and procedures. This will always be a challenge during periods of economic expansion, where financial institutions are experiencing low levels of nonperforming loans and loan losses, strong capital and robust earnings. Under these circumstances supervisors are subject to being accused by financial institutions and policy makers as impeding economic progress and credit availability. It would be beneficial to take a stronger and more aggressive posture regarding concentration risk and funding and asset/liability management risk during periods of economic expansion.Q.9. G20 Summit and International Coordination--Many foreign officials and analysts have said that they believe the upcoming G20 summit will endorse a set of principles agreed to by both the Financial Stability Forum and the Basel Committee, in addition to other government entities. There have also been calls from some countries to heavily re-regulate the financial sector, pool national sovereignty in key economic areas, and create powerful supranational regulatory institutions. (Examples are national bank resolution regimes, bank capital levels, and deposit insurance.) Your agencies are active participants in these international efforts. What do you anticipate will be the result of the G20 summit? Do you see any examples or areas where supranational regulation of financial services would be effective? How far do you see your agencies pushing for or against such supranational initiatives?A.9. To ensure a comprehensive regulatory system for credit unions, Congress should consider the current dual chartering system as a regulatory model. Dual chartering and the value offered to consumers by the state and federal systems provide the components that make a comprehensive regulatory system. Dual chartering also reduces the likelihood of gaps in financial regulation because there are two interested regulators. Often, states are in the first and best position to identify current trends that need to be regulated and this structure allows the party with the most information to act to curtail a situation before it becomes problematic. Dual chartering should continue. This system provides accountability and the needed structure for effective and aggressive regulatory enforcement. The dual chartering system has provided comprehensive regulation for 140 years. Dual chartering remains viable in the financial marketplace because of the distinct benefits provided by each charter, state and federal. This system allows each financial institution to select the charter that benefits its members or consumers the most. Ideally, for any system, the best elements of each charter should be recognized and enhanced to allow for competition in the marketplace so that everyone benefits. In addition, the dual chartering system allows for the checks and balances between state and federal government necessary for comprehensive regulation. Any regulatory system should recognize the value of the dual chartering system and how it contributes to a comprehensive regulatory structure. Regulators should evaluate products and services based on safety and soundness and consumer protection criterion. This will maintain the public's confidence. ------ CHRG-111hhrg58044--314 Mr. Rukavina," Chairman Gutierrez, Ranking Member Hensarling, and members of the subcommittee, I thank you for the opportunity to address the committee today. My name is Mark Rukavina, and I am executive director of the Access Project. We work nationally on health care issues, and have since 1998. And our research played an instrumental role in revealing the problem of medical debt. Medical debt is money owed for any type of medical service or product. That money may be owed directly to the provider of the service, or to an agent of the provider, such as a collection agency. In my testimony today, I would like to discuss the use of medical debt in assessing one's creditworthiness. And more detailed information is found in my written testimony. First, some background on medical debt. Data gathered by the Commonwealth Fund found that during 2007, the most recent year for which data are available: 49 million working-aged Americans and 7 million elderly adults had medical debt or medical bills that they were paying off over time; and 28 million working-aged adults were contacted by collection agencies for medical bills. What makes medical bills unique? Few Americans understand that nearly two-thirds of the people who have medical debt had insurance at the time of the incident for which they owe money. While insurance provides protection, patients still have out-of-pocket obligations that they must pay. Americans are often confused by their health insurance coverage. One national study found that nearly 40 percent of Americans did not understand their medical bills or the explanation of benefits. They did not know what service they were supposed to pay for, the amount they owed, or whether that amount was correct. Nearly one-third let a medical bill go to collection, and one in six did not know whether they should pay their health care provider or their insurance company. Given this, it is not surprising when claims that are not promptly paid get sent to collection. The confusion regarding medical claims payment also carries over to credit reports. Many Americans mistakenly believe that unpaid medical bills have no influence over a credit score. The lack of clarity may stem from statements made by industry representatives. Testimony from the previous panel was an example of this. However, in recent testimony before this committee, a VantageScore representative said that their score does not factor medical debt into the calculation of a consumer's credit score. Following that hearing, a letter was sent to the committee to clarify that this only applies when that medical debt is reported directly by a health care provider. They also clarified that they include all collection accounts, including those related to medical debt, when calculating a credit score. Given this, it is important to understand how most medical data appear on people's reports. According to Experian, data provided directly by medical providers accounts for only 7/100ths of one percent of the data that they gather. TransUnion states that medical debts are not typically reported unless they become delinquent and are assigned to collections. So, here are the facts. Forty percent of Americans are confused by medical bills. Consumers and some credit scoring agencies appear confused as to whether medical data are used in calculating credit scores. Medical data can only drag down one's score. I say this because medical debts that are paid off directly to providers aren't used in calculating one's score. Medical accounts are only included on credit reports if they are deemed delinquent and sent to collection. This system is stacked against consumers, and penalizes those who experience illness. Even when proper action is taken, and one pays off a medical bill, the Fair Credit Reporting Act allows for this bill to remain on a person's report for up to 7 years. This leads me to question the predicted value of medical accounts, which has also been questioned by some of those in the financial service industry. Some lenders disregard them when reviewing loan applications. A study published in the Federal Reserve Bulletin found that nearly one-third of Americans with a credit file have a collection account on their credit report. The study found that more than half of the accounts in collection are medical accounts. It went on to state that, ``some credit evaluators report that they remove collection accounts related to medical services from credit evaluations because such accounts often involve disputes with insurance companies over liability for the accounts or because the account may not indicate future performance on loans.'' It is estimated that in 2008, Americans spent $277 billion in out-of-pocket costs. This resulted from millions of invoiced medical bills. Millions of Americans had bills sent to collection as the result of a lengthy insurance claim adjudication process or confusion due to numerous bills generated from one visit to a hospital. Those who paid their bills in full are often very surprised when they learn that despite such actions, the bills continue to plague them and peg them as poor credit risks. Such data errors harm consumers, and these inaccuracies in credit reports slow America's economic recovery. H.R. 3421 addresses this problem, it corrects these errors on credit reports. Specifically, it would require-- " CHRG-111shrg55739--84 Mr. Coffee," I am honored, Chairman Reed and fellow Members of the Committee, to be back before this Committee, but I am in the very embarrassing position of having to begin by commending and congratulating the Chairman, because what we are looking at in the Treasury bill is 95 percent what was in the Reed bill. The Reed bill, introduced in April, was substantial, constructive, well crafted, and I think it does just about everything that you can do through administrative regulation to deal with this problem. The problem is, there are dimensions to this whole area that are beyond simply administrative regulation and that is what the Treasury bill in particular leaves out. Thus, because--there is a shortfall, because not all of the provisions in the Reed bill are in the Treasury bill and because there needs to be a consideration of some issues beyond administrative regulation. I would have to say there is a shortfall in the Treasury regulation, and I would have to predict that we will see a persistence of the status quo, dysfunctional and perverse as it is, if all we do is what is in the Treasury bill. In this regard, I think there are two distinctive critical features about credit rating agencies which distinguish them from all of the other gatekeepers in the financial markets that have to be focused on. One, credit rating agencies do not perform due diligence. Accountants are bean counters. They go out and count the beans. Credit rating agencies give ratings based on hypothetical assumed facts, and thus you are getting hypothetical ratings. I think that has to be corrected. Second, the credit rating agencies today do not face any meaningful risk of liability. Because, as I look at the future, even though I wish to encourage the user-pay system, I think the issuer-pays model will persist and predominate. There is going to remain a built-in conflict of interest, and when you have a built-in conflict of interest, the other professions have found that the only thing that keeps the professional honest is the threat of litigation. The accountants have learned, painfully, how to steer a course between acquiescence to the client and maintaining high integrity and litigation is one of the forces that maintains that equilibrium. Therefore, based on that diagnosis, what do I think we should do? I think the first thing we have to focus on is how to encourage third-party due diligence. The Treasury bill does this, largely adopting many of your provisions. The problem is that it does this by requiring disclosure when you decide to use a third-party due diligence firm, and it requires certification by that firm to the SEC. That raises the cost of using a third-party due diligence firm and I think there would be many underwriters, at least if we get back into a bull market at some point in the future, that will simply opt not to use the third-party due diligence firm. They did this in the past. These due diligence firms were widely employed in the 1990s, and as the market grew bubbly, they dropped their use because they kept learning disquieting facts that they didn't want to hear about. So you can put in boilerplate disclosure that says, we are not using a third-party due diligence firm, and hope that in that more favorable market, you can get away with this, and I think you probably would be able to get away with this. How, then, should we deal with encouraging third-party due diligence? I would suggest that we look here at a different level of regulation. No one has been talking much about regulating the users of this information, and the users now are closely regulated by rules that I think are over-broad and ill conceived. Let me give you one example. Rule 2(a)(7) of the SEC under the Investment Company Act tells money market funds that they cannot buy securities unless they are eligible securities, and to be an eligible security, you have to have a requisite rating from an NRSRO rating agency. We could deregulate much of that, but many of the users of this information do want to rely on an NRSRO rating. They have made that very clear to the SEC. What I think we should say is that to the extent you choose to rely on an NRSRO rating, it has to be a rating that is based upon third-party due diligence that verified the essential facts. That way, we have at least something that is not illusory, that is not a hypothetical rating, and that way--because this rule already exists. I am not proposing new rules. I am proposing making the existing rule meaningful by making it based on third-party due diligence. There are other of these rules, but they are in my statement and I won't take it further. The point in doing this is by focusing on the user, we are not regulating the rating agency and that allows us to sidestep some arguable constitutional problems about whether we are overly regulating commercial speech. I don't think we are, but we aren't doing it at all if we regulate the user and say, you only get the right to do this if you use one of these techniques and you have good due diligence. Now, let me move on to this issue of liability because I see the business-pays model as persisting. I think we need some risk. In 10 seconds, let me just say that my proposal is not to open the flood gates. It is really your proposal. I think you struck a very sensible compromise, because it doesn't really increase the likelihood of litigated outcomes. It simply says, your proposal, your bill in April contains a provision that says if credit rating agencies--they can be found to have acted recklessly if they give an opinion, a rating, without conducting some due diligence or receiving due diligence from a third-party expert. This does not subject them to liability. It just tells them there is one easy, safe strategy for avoiding liability and that is to make sure that the underwriter pays for and gives you a third-party due diligence report that covers the critical facts in your model. This will not produce a rash of litigation. It will produce behavior that avoids litigation and thus this is another technique to get the critical core of due diligence back into the ratings process. Thank you. I apologize for overstepping my time. Senator Reed. Thank you, Professor Coffee. Professor White.STATEMENT OF LAWRENCE J. WHITE, LEONARD E. IMPERATORE PROFESSOR CHRG-111shrg50814--162 Mr. Bernanke," Senator, there are two sides to this. One side is providing the capital they need to provide credit to the economy, which is essential. But we are not just handing them this capital and saying, go do your thing. We also have on the other side the supervisory oversight, the TARP oversight, to make sure that they are not just sitting around but that they are taking the steps necessary to clean themselves up so that they will be profitable in the future. At that point, private capital will come in and public capital can go out. And as I was saying before, the best sign of success will be when the government can start taking its capital out, or the banks can start replacing the public capital with private sector capital. That is what we are aiming for. Senator Corker. I just took your comment earlier, you know, there are a lot of assumptions about what our public policy is and I think people understand about the condition that Senator Shelby mentioned about too big to fail. But when you stated earlier, we are committed to ensuring the viability of all major U.S. financial institutions, that is a statement that I guess I have never heard said that clearly before and I think that some of us have expected that there is at least a possibility if a financial institution is not performing properly they might be seized, which is certainly a form of nationalization, for a period of time, but it is different. It is under different circumstances. But what I hear you saying today--again, I am not being critical, I might be later, but I am just observing right now--is that we are going to get them to sort of take their medicine. We are going to go in and make them reserve up for these accrual loans that we know is where the next huge hole is, but we are going to give them public dollars. I mean, that, to me, and I certainly haven't been around that long here, but that, to me, is nationalization. I mean, that--I would like for you to give me a term to use as I leave here as to what we would call that. " FOMC20060510meeting--106 104,MS. PIANALTO.," Thank you, Mr. Chairman. Based on the reports from my directors and my business contacts in the Fourth District, the relatively broad-based growth of the first quarter appears to have carried over into April. However, their comments about the balance of the year are consistent with the moderating trend of the Greenbook baseline projection. To put it in terms used by the Conference Board’s consumer sentiment measures, the current condition index is high, but the expectations index is falling. I was reminded by my staff as we were preparing for this meeting that real-time data on real economic growth are difficult to assess. At the end of our rate-increase cycle in 2000, the GDP figures were providing unreliable signals about the underlying strength of the economy. We had a second quarter that had real growth of more than 6 percent. We were forecasting, and even saw in the advance figures a very strong third quarter, and yet we had negative growth in that quarter. Comments I hear about price pressures contain some mixed messages. I don’t hear many complaints about price pressures except for the obvious ones about the energy-related costs and material shortages in construction-related businesses. However, I am hearing concerns about the persistence of these costs and the possibility that they may have negative consequences for both inflation and overall business conditions. The consequences of the energy shocks for prices are already apparent. At our November meeting, I agreed with the Board staff projection that we would, at about this time, find ourselves facing some pass-through in our core inflation measures from some of the previous energy-price increases. At that time, however, it also appeared that headline inflation would be coming down at this point. Obviously, the current Greenbook suggests that recent oil shocks have taken that scenario away from us, at least for the immediate future, and the tick-up in expected core inflation is now even further away from my comfort zone than before. That said, based on what I’m hearing from my directors and business contacts, the Greenbook’s assessment of current conditions and baseline projections going forward seem about right to me. But I sense rather significant perceived risks both that economic growth might turn out weaker than I expect and that inflationary pressures might be larger or even more persistent than I expect. If we can take any encouragement from this, it would be that similar sentiments were expressed during the run-up in oil and gas prices last fall, and those sentiments did abate fairly quickly when the energy market situation stabilized. Unlike many of my colleagues who have spoken ahead of me, I do think that the risks are weighted against both of our objectives, and, obviously, that’s not a comfortable place for a monetary policymaker to be in. Thank you, Mr. Chairman." FOMC20070628meeting--152 150,MR. KROSZNER.," So, on your estimate, what we will be seeing tomorrow when we get the details on prices will be in line with what you have been expecting? There was nothing here to make you change your view of that? MR.WILCOX. We don’t know the details of what we will get tomorrow, but there is nothing here to condition our expectation any differently from what we had before." CHRG-109hhrg31539--173 Mr. Bernanke," The purchase of a bank by a commercial firm violates the separation of banking and commerce, and so I wouldn't advise allowing that, but if you do allow it, then it would be better to have consolidated supervision, which includes an overview of the financial condition of the parent, that is, the commercial firm as well as of the ILC subsidiary. " FOMC20080916meeting--164 162,MR. DUDLEY.," I would say that the markets will take it as a statement that is conditional on what happens in markets. If markets get sufficiently bad, if there is some threshold of deterioration, that can potentially provoke an intermeeting move is the way I think they would take it. Brian, would you agree with that? " CHRG-111shrg57320--33 Mr. Thorson," Yes, sir. I think I pulled back a point in my statement that said basically assigning a ``satisfactory'' rating when conditions are not is contrary to the very purpose for which regulators use a rating system. I think that is what you are saying. Senator Coburn. Any comments on that, Mr. Rymer. " FinancialCrisisInquiry--678 GRAHAM: Ms. Gordon, you made some very strong statements about the fact that there was a preference given to the worst mortgages and actual economic incentives to create harsh conditions and possibly overprice to the consumer mortgages. What is—do you have some evidence to substantiate those charges? January 13, 2010 CHRG-110shrg50409--19 Mr. Bernanke," Well, Senator, as you point out, we are not the primary regulator of that institution, but we were involved in it---- Senator Shelby. Absolutely. " Mr. Bernanke," ----because the Federal Reserve Bank of San Francisco was attempting to assist in the wind down, and we certainly had extensive communication with the FDIC and the OTS about that bank. My assessment of IndyMac is that it was particularly weighted down with low-quality mortgages, subprime and other exotic mortgages, and those losses created a capital hole that it was unable to fill. So in that respect, I think its failure, barring acquisition by another firm, which did not occur, was inevitable. So, again, I think it was basically the asset quality of the bank that had that effect. Of course, all banks are being challenged by credit conditions now. The good news is that the banking system did come into this episode extremely well capitalized, extremely profitable. I do not have any forecast to make. I think Chairman Bair gave a good discussion yesterday about the pressures that banks are facing, and she discussed her list of problem banks. I suppose it is a bit of good news that most of the problem banks that she had is a far smaller list than we have seen in some episodes in the past, in the 1990s, for example. Senator Shelby. Overall, looking at our banking system, could you say today here in the Senate that you believe as Chairman of the Federal Reserve that our banking system is stable and capitally strong? " CHRG-111shrg50814--33 Mr. Bernanke," Well, the major banks all meet current regulatory capital standards, and well capitalized is a well defined regulatory term. The purpose of these assessments we are going to do going forward is to make sure that banks have enough capital not only to be well capitalized in what we expect to be the weak conditions that we will see in the next year, but even under conditions that are weaker than expected. And moreover, we want to make sure that they have good quality capital, that is that a sufficient portion of their capital is in common stock and not in other forms of capital. So the purpose of these tests is to try to assess how much additional capital and what kind of capital they need so they will be able to lend and support the economy even in a situation worse than we currently expect. Senator Reed. Listening to your response to Senator Shelby, though, you seem to be skeptical about the adequacy of the current test, the current capital test, capital definitions. So even if we move through this very difficult moment, someone passes the stress test or gets help if they can't pass the stress test, there is real question in your mind about how regulators measures capital, what should be included, is that a fair assessment? " FOMC20070918meeting--206 204,CHAIRMAN BERNANKE.," Without objection. Thank you. The first issue is the need for dollar funding and dollar term funding by European banks, which has caused problems in Europe but also has bled over to some extent to dollar markets in the United States. We have been in conversations at various times with Europe about a swap arrangement that would provide dollars to Europe to address this issue, but the issue has not yet, obviously, been brought to you as a Committee. The second issue that we have been looking at is how to address the stigma of the discount window. Are there ways to provide liquidity that would help normalize money markets, particularly term money markets, and would allow banks to make use of the enormous amount of collateral they have at the discount window, but would avoid the stigma and create a more efficient system? The solution that the staff came up with on that was to have an auction facility that would essentially set an endogenous price and, because it was an auction, it might look more like a good business proposition rather than like a move of desperation and, therefore, would not have the same stigma. So there are these two separate issues—the auction facility as a way of addressing the stigma of the discount window and the swap as a way of getting dollars into the European dollar markets. Some conversations that I had, in particular with President Trichet of the European Central Bank, came up with the possibility of combining these two things, essentially having auctions simultaneously in the United States and in Europe, and then using the swap markets to provide the dollars to the extent that the ECB would like to have them. The Swiss National Bank expressed interest in joining this as well. In a moment you will be hearing from the staff a few details about these proposals. Now, let me just say a couple of things. First, one thing on governance is that the rules here are that the auction credit facility requires an amendment of regulation, which is a province of the Board, so in that respect it’s a Board decision. However, obviously, the Bank presidents are very much involved in this because it would involve discount window management, and therefore, I think it’s fair for us to have the discussion of this from the perspective of the entire Committee. Second, the swaps would be, of course, a decision of the FOMC, and they obviously would need a vote. We began working on this some weeks ago when the markets were in a particularly stressful condition, and our hope was to try to normalize those markets. As I said earlier today, the markets seem to be getting better, and this may not be the exact moment that we want to be doing this. However, it might be a good idea to have this process or, alternatively, the two separate processes—we could do either one without the other—available should market conditions demand it. So what I would like to propose is that we have a presentation; some comments, discussion, and questions from you; and we’ll get a sense of the Committee in terms of where you are on this. What I will commit to is that we won’t take any votes today, but before using either option or a combination of both options, we will have a videoconference and ask for your formal approval of the swaps and at least your consent to the ACF. So we are not planning to implement this immediately, but we would like to have the possibility of having it as an option, should money markets seem to require it. So with that, let me turn to the staff." FOMC20070321meeting--182 180,CHAIRMAN BERNANKE.," Let me just ask a question. The intention of this was not to comment on recent market volatility. The intention was to say that interest rates are low, stock prices are pretty strong, and liquidity is good, and that is going to support growth. Would changing it to, say, “aided by supportive financial conditions” or something like that, be of any help?" CHRG-110hhrg46596--191 The Chairman," Mr. Dodaro, let me ask you to comment, but first let me take some credit of there is a credit scarcity in this country, one of money to lend, and two, for anything we do. We never get any credit. So I want to give us some. One of the criticisms made of the bill was it didn't have adequate oversight. Now, there was a slowdown in the creation of the congressional panel. My guess is some who were complaining that there was too little oversight, now that we have that congressional panel will be heard to complain that there is too much of it. I myself welcome it. But we did write--and we still have a pending confirmation in the Senate of an Inspector General. But we knew that the GAO was there, we know--there are few institutions around here that are as respected across the ideological and political spectrum as the GAO. And we were very pleased, as you know, Mr. Dodaro, we met with you early. You reported to us that with the cooperation of Secretary Paulson and Mr. Kashkari you were on the ground as soon as this startup was there. You had people there. And the very fact that we are here talking about a report which gives them some credit and some criticism I think testifies to the adequacy at the very least of the oversight parts of the bill. But would you now comment on Mr. Kashkari's--are you in on these discussions? Do you have some confidence about them going forward? " CHRG-111shrg55117--7 Mr. Bernanke," Thank you. Chairman Dodd, Ranking Member Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. Aggressive policy actions taken around the world last fall may well have averted the collapse of the global financial system, an event that would have had extremely adverse and protracted consequences for the world economy. Even so, the financial shocks that hit the global economy in September and October were the worst since the 1930s, and they helped push the global economy into the deepest recession since World War II. The U.S. economy contracted sharply in the fourth quarter of last year and the first quarter of this year. More recently, the pace of decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization. The labor market, however, has continued to weaken. Consumer price inflation, which fell to low levels late last year, remained subdued in the first 6 months of 2009. To promote economic recovery and foster price stability, the Federal Open Market Committee last year brought its target for the Federal funds rate to a historically low range of 0 to \1/4\ percent, where it remains today. The FOMC anticipates that economic conditions are likely to warrant maintaining the Federal funds rate at exceptionally low levels for an extended period. At the time of our February report, financial markets at home and abroad were under intense strains, with equity prices at multiyear lows, risk spreads for private borrowers at very elevated levels, and some important financial markets essentially shut. Today, financial conditions remain stressed, and many households and businesses are finding credit difficult to obtain. Nevertheless, on net, the past few months have seen some notable improvements. For example, interest rate spreads in short-term money markets, such as the interbank market and the commercial paper market, have continued to narrow. The extreme risk aversion of last fall has eased somewhat, and investors are returning to private credit markets. Reflecting this greater investor receptivity, corporate bond issuance has been strong. Many markets are functioning more normally, with increased liquidity and lower bid-asked spreads. Equity prices, which hit a low point in March, have recovered to roughly their levels at the end of last year, and banks have raised a significant amount of new capital. Many of the improvements in financial conditions can be traced, in part, to policy actions taken by the Federal Reserve to encourage the flow of credit. For example, the decline in interbank lending rates and spreads was facilitated by the actions of the Federal Reserve and other central banks to ensure that financial institutions have access to adequate amounts of short-term liquidity, which in turn has increased the stability of the banking system and the ability of banks to lend. Interest rates and spreads on commercial paper dropped significantly as a result of the backstop liquidity facilities that the Federal Reserve introduced last fall for that market. Our purchases of agency mortgage-backed securities and other longer-term assets have helped lower conforming fixed mortgage rates. And the Term Asset-Backed Securities Loan Facility, or TALF, which was implemented this year, has helped to restart the securitization markets for various classes of consumer and small business credit. Earlier this year, the Federal Reserve and other Federal banking regulatory agencies undertook the Supervisory Capital Assessment Program, popularly known as the ``stress test,'' to determine the capital needs of the largest financial institutions. The results of the SCAP were reported in May, and they appeared to increase investor confidence in the U.S. banking system. Subsequently, the great majority of institutions that underwent the assessment have raised equity in public markets. And, on June 17, 10 of the largest U.S. bank holding companies--all but one of which participated in the SCAP--repaid a total of nearly $70 billion to the Treasury. Better conditions in financial markets have been accompanied by some improvement in economic prospects. Consumer spending has been relatively stable so far this year, and the decline in housing activity appears to have moderated. Businesses have continued to cut capital spending and liquidate inventories, but the likely slowdown in the pace of inventory liquidation in coming quarters represents another factor that may support a turnaround in activity. Although the recession in the rest of the world led to a steep drop in the demand for U.S. exports, this drag on our economy also appears to be waning, as many of our trading partners are also seeing signs of stabilization. Despite these positive signs, the rate of job loss remains high and the unemployment rate has continued its steep rise. Job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending. The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook. In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared economic projections covering the years 2009 through 2011. FOMC participants generally expect that, after declining in the first half of this year, output will increase slightly over the remainder of 2009. The recovery is expected to be gradual in 2010, with some acceleration in activity in 2011. Although the unemployment rate is projected to peak at the end of this year, the projected declines in 2010 and 2011 would still leave unemployment well above FOMC participants' views of the longer-run sustainable rate. All participants expect that inflation will be somewhat lower this year than in recent years, and most expect it to remain subdued over the next 2 years. In light of the substantial economic slack and limited inflation pressures, monetary policy remains focused on fostering economic recovery. Accordingly, as I mentioned earlier, the FOMC believes that a highly accommodative stance of monetary policy will be appropriate for an extended period. However, we also believe that it is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation. The FOMC has been devoting considerable attention to issues relating to its exit strategy, and we are confident that we have the necessary tools to implement that strategy when appropriate. To some extent, our policy measures will unwind automatically as the economy recovers and financial strains ease, because most of our extraordinary liquidity facilities are priced at a premium over normal interest rate spreads. Indeed, total Federal Reserve credit extended to banks and other market participants has declined from roughly $1.5 trillion at the end of 2008 to less than $600 billion, reflecting the improvement in financial conditions that has already occurred. In addition, bank reserves held at the Fed will decline as the longer-term assets that we own are maturing or are prepaid. Nevertheless, should economic conditions warrant a tightening of monetary policy before this process of unwinding is complete, we have a number of tools that will enable us to raise market interest rates as needed. Perhaps the most important such tool is the authority that the Congress granted the Federal Reserve last fall to pay interest on balances held at the Fed by depository institutions. Raising the rate of interest paid on reserve balances will give us substantial leverage over the Federal funds rate and other short-term market interest rates, because banks generally will not supply funds to the market at an interest rate significantly lower than they can earn risk free by holding balances at the Federal Reserve. Indeed, many foreign central banks use the ability to pay interest on reserves to help set a floor on market interest rates. The attractiveness to banks of leaving their excess reserve balances with the Federal Reserve can be further increased by offering banks a choice of maturities for their deposits. But interest on reserves is by no means the only tool we have to influence market interest rates. For example, we can drain liquidity from the system by conducting reverse repurchase agreements, in which we sell securities from our portfolio with an agreement to buy them back at a later date. Reverse repurchase agreements, which can be executed with primary dealers, Government-sponsored enterprises, and a range of other counterparties, are a traditional and well-understood method of managing the level of bank reserves. If necessary, another means of tightening policy is outright sales of our holdings of longer-term securities. Not only would such sales drain reserves and raise short-term interest rates, but they also could put upward pressure on longer-term interest rates by expanding the supply of longer-term assets. In sum, we are confident that we have the tools to raise interest rates when that becomes necessary to achieve our objectives of maximum employment and price stability. Our economy and financial markets have faced extraordinary near-term challenges, and strong and timely actions to respond to those challenges have been necessary and appropriate. I have discussed some of the measures taken by the Federal Reserve to promote economic growth and financial stability. The Congress also has taken substantial actions, including the passage of a fiscal stimulus package. Nevertheless, even as important steps have been taken to address the recession and the intense threats to financial stability, maintaining the confidence of the public and financial markets requires that policy makers begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and the continued increases in the costs of Medicare and Medicaid. Addressing the country's fiscal problems will require difficult choices, but postponing those choices will only make them more difficult. Moreover, agreeing on a sustainable long-run fiscal path now could yield considerable near-term economic benefits in the form of lower long-term interest rates and increased consumer and business confidence. Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth. A clear lesson of the recent financial turmoil is that we must make our system of financial supervision and regulation more effective, both in the United States and abroad. In my view, comprehensive reform should include at least the following key elements: A prudential approach that focuses on the stability of the financial system as a whole, not just the safety and soundness of individual institutions, and that includes formal mechanisms for identifying and dealing with emerging systemic risks; Stronger capital and liquidity standards for financial firms, with more stringent standards for large, complex, and financially interconnected firms; The extension and enhancement of supervisory oversight, including effective consolidated supervision, to all financial organizations that could pose a significant risk to the overall financial system; An enhanced bankruptcy or resolution regime, modeled on the current system for depository institutions, that would allow financially troubled, systemically important nonbank financial institutions to be wound down without broad disruption to the financial system and the economy; Enhanced protections for consumers and investors in their financial dealings; Measures to ensure that critical payment, clearing, and settlement arrangements are resilient to financial shocks, and that practices related to the trading and clearing of derivatives and other financial instruments do not pose risks to the financial system as a whole; And, finally, improved coordination across countries in the development of regulations and in the supervision of internationally active firms. The Federal Reserve has taken and will continue to take important steps to strengthen supervision, improve the resiliency of the financial system, and to increase the macroprudential orientation of our oversight. For example, we are expanding our use of horizontal reviews of financial firms to provide a more comprehensive understanding of practices and risks in the financial system. The Federal Reserve also remains strongly committed to effectively carrying out our responsibilities for consumer protection. Over the past 3 years, the Federal Reserve has written rules providing strong protections for mortgage borrowers and credit card users, among many other substantive actions. Later this week, the Board will issue a proposal using our authority under the Truth in Lending Act, which will include new, consumer-tested disclosures as well as rule changes applying to mortgages and home equity lines of credit; in addition, the proposal includes new rules governing the compensation of mortgage originators. We are expanding our supervisory activities to include risk-focused reviews of consumer compliance in nonbank subsidiaries of holding companies. Our community affairs and research areas have provided support and assistance for organizations specializing in foreclosure mitigation, and we have worked with nonprofit groups on strategies for neighborhood stabilization. The Federal Reserve's combination of expertise in financial markets, payment systems, and supervision positions us well to protect the interests of consumers in their financial transactions. We look forward to discussing with the Congress ways to further formalize our institution's strong commitment to consumer protection. Finally, the Congress and the American people have a right to know how the Federal Reserve is carrying out its responsibilities and how we are using taxpayers' resources. The Federal Reserve is committed to transparency and accountability in its operations. We report on our activities in a variety of ways, including reports like the one I am presenting to the Congress today, other testimonies, and speeches. The FOMC releases a statement immediately after each regularly scheduled meeting and detailed minutes of each meeting on a timely basis. We have increased the frequency and scope of the published economic forecasts of FOMC participants. We provide the public with detailed annual reports on the financial activities of the Federal Reserve System that are audited by an independent public accounting firm, and we publish a complete balance sheet each week. We have recently taken additional steps to better inform the public about the programs we have instituted to combat the financial crisis. We expanded our Web site this year to bring together already available information as well as considerable new information on our policy programs and financial activities. In June, we initiated a monthly report to the Congress that provides even more information on Federal Reserve liquidity programs, including breakdowns of our lending, the associated collateral, and other facets of programs established to address the financial crisis. These steps should help the public understand the efforts that we have taken to protect the taxpayer as we supply liquidity to the financial system and support the functioning of key credit markets. The Congress has recently discussed proposals to expand the audit authority of the GAO over the Federal Reserve. As you know, the Federal Reserve is already subject to frequent reviews by the GAO. The GAO has broad authority to audit our operations and functions. The Congress recently granted the GAO new authority to conduct audits of the credit facilities extended by the Federal Reserve to ``single and specific'' companies under the authority provided by section 13(3) of the Federal Reserve Act, including the loan facilities provided to, or created for, AIG and Bear Stearns. The GAO and the Special Inspector General have the right to audit our TALF program, which uses funds from the Troubled Assets Relief Program. The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in making and executing monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of Members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence. Thank you, Mr. Chairman. " CHRG-110shrg50416--129 Chairman Dodd," Well, staff reminds me that the second loan was made after the spa story. It would seem to me that that story might have been enough to provoke the Fed to take some action, that second tranche was at least going to be conditioned better than it was. Well, I wish you would carry this back. Ms. Duke. I will. I will " CHRG-111hhrg54873--29 Mr. Gallagher," Chairman Kanjorski, Ranking Member Garrett, and members of the subcommittee, my name is Dan Gallagher, and I am a Co-Acting Director at the Division of Trading and Markets at the Securities and Exchange Commission. Thank you for the opportunity to testify today regarding the oversight of credit rating agencies. I note at the outset that my written testimony today was approved by the Commission, but any remarks I make today, in particular on the draft bill, will be my own and may not reflect the views of the Commission. The poor performance of highly-rated securities over the last few years has resulted in substantial investor losses and increased market turmoil. As we work to restore the health of the markets, it is vital that we take further steps to improve the integrity and the transparency of the ratings process to promote competition among rating agencies and give investors the appropriate context for evaluating ratings. The proposed legislation Chairman Kanjorski recently released for discussion contains a number of measures that could enhance the Commission's oversight program, including provisions designed to address conflicts of interest, a lack of transparency and limited accountability in the credit rating industry. I would note that over the last few years, the Commission has been addressing a number of these issues and we welcome the opportunity to discuss these efforts. As you know, Congress provided the Commission with authority to register and oversee nationally recognized statistical rating organizations, NRSROs, in the Credit Rate Agency Reform Act of 2006. In the summer of 2007, using our new oversight authority and in response to gradually worsening marketing conditions, the Commission staff began examination of the three largest NRSROs--Fitch, Moody's, and Standard & Poor's--to look into their policies and practices relating to ratings of structured finance products linked to aggressively underwritten mortgages. To put it bluntly, the examinations revealed a number of serious problems. In particular, the examinations raised serious questions about the NRSROs' management of conflicts of interest, internal audit processes, and due diligence activities. Findings from these initial examinations informed a second round of rule amendments which the Commission proposed in June of 2008 and adopted in February of 2009. Earlier this month, on September 17th, the Commission embarked on further rulemaking designed to promote greater accountability, foster competition, decrease the level of undue reliance on NRSROs, and empower investors to make more informed decisions. The Commission adopted rule amendments designed to create a mechanism for NRSROs not hired to rate structured finance products to nonetheless determine and monitor credit ratings for these instruments. The goal of this rule is to make it possible for nonhired NRSROs to provide unsolicited ratings in the structured finance market just like they can in the corporate debt market. The Commission also adopted a requirement that NRSROs must disclose ratings history information for all outstanding ratings initially determined on or after June 26, 2007. This new disclosure requirement is designed to promote greater transparency of ratings, quality and increased accountability among NRSROs. The Commission also published for comment three sets of new requirements for NRSROs. The first proposal would increase accountability by requiring NRSROs to furnish the Commission with an annual compliance report describing actions taken to ensure compliance with the securities laws. The goal of this proposal is to increase accountability by strengthening the compliance function at the NRSROs and to alert the Commission to issues that may need to be examined. The second and third proposals would increase the information NRSROs must disclose to the public about the conflict of being paid for determining credit ratings and other services. These disclosures which would include a consolidated annual report are designed to provide investors with additional information on the source and magnitude of revenue, including revenues from non-rating services that an NRSRO receives from its clients. Notably, in its recent rulemaking, the Commission also proposed rating disclosure requirements for issuers of securities. For example, the Commission proposed amendments that would require certain detailed disclosures regarding credit ratings and registration statements. The Commission also proposed requiring the disclosure of preliminary ratings, as well as final ratings not used by an issuer so that investors would be informed when an issuer may have engaged in rating shopping. The Commission also took action to eliminate references to NRSRO credit ratings in certain of its rules and forms. This is designed to address concerns that references to NRSRO ratings and Commission rules may have contributed to an undue reliance on those ratings by market participants and the Commission found that the removal of references either improved the rules or had no effect on them. Finally, the Commission issued a concept release seeking comment on whether it should propose rescinding a rule that exempts NRSROs from expert liability under Section 11 of the Securities Act. Rescinding Rule 436(g), coupled with the proposal to require disclosure of credit ratings in a registration statement if a rating is used in connection with a registered offering, could cause NRSROs to be included in the liability scheme for experts set forth in Section 11. The Commission appreciates Congress' interest in this issue, and we stand ready to provide any assistance the subcommittee might need in its consideration of measures to reform the financial markets. I would be happy to answer any questions you may have. Thank you. [The prepared statement of Mr. Gallagher can be found on page 60 of the appendix.] " CHRG-111shrg50815--31 Chairman Dodd," Thank you very much, and I appreciate your comments, and all of you here this morning for your counsel on this issue, which is, again, a complex one and one that deserves our attention. I want to also make two points. One is credit cards are a tremendously valuable and worthwhile tool for consumers. I think it is very important. This is not a Committee, or at least an individual here that is hostile to the notion of credit cards at all. Quite the contrary. Second, I respect immensely that Ben Bernanke and the Federal Reserve moved on the issue of regulation, and while there are gaps and problems I have with what they have done, he is the first Chairman of the Fed that has actually moved in this area, despite the issue having been raised for a long time, and I certainly want to reflect my appreciation for the steps they have taken. I am disappointed that you have got to wait until July of 2010 for them to become effective, but nonetheless I want the record to reflect it. I was very impressed, Mr. Levitin, with this study and I highly recommend to my colleagues. It is lengthy in some ways. It is a number of pages long, some 20 pages long, this analysis of the credit card industry and how it works. But one thing that struck me at the outset of the report is something I think we kind of blow through, and that is the credit instruments that we use as Americans are tremendously valuable--the home mortgage, the car loan, the student loan. And the point that you make, or that this report makes is, of course, the pricing points, and I think it is a very worthwhile point to make. In almost every one of these other transactions, pricing points are rather clear. They are one or two or three, maybe four, but you have a pretty clear idea. You know with almost certainty what your mortgage is going to be, what your car payments are going to be, what your other payments are regardless if you take credit. When you get into this area, it is exactly the opposite, and I was stunned at the pricing points and why, in terms of taking on this responsibility, knowing what your responsibilities are going to be, you are faced with the following, just on pricing points, an astounding array of points--annual fees, merchant fees, teaser interest rates, base interest rates, balance transfer interest rates, cash advance interest rates, overdraft interest rates, default interest rates, late fees, over-limit fees, balance transfer fees, cash advance fees, international transaction fees, telephone payment fees. These are all the pricing points in credit card negotiations. To expect a consumer to appreciate and absorb that many pricing points when you are trying to determine whether or not taking on that financial responsibility--now, again, we are not going to eliminate all of these, but the idea that a consumer is able to juggle and understand that many different pricing points when you are making a determination as to whether or not you ought to engage in a service or a product purchase. I was stunned, as well, on the issues of bankruptcy and the like in terms of driving these costs up and the complexity of dealing with it. Again, I draw my colleagues' attention to this report. I think it is extremely useful. It gets into the issue of the risk-based pricing issue, as well, that Dr. Ausubel referenced, but I think it is an important point, as well. It is an industry that started out making its money on interest rates, and that was where the money was made. It has transferred itself from interest rates to fees, and that is the $12 billion increase in fees that have occurred that have added so much cost and confusion. Mr. Clayton, thank you for being here. One of the issues that is obviously of concern to many of us is the universal default. I think most people understand it, but the idea that if you are current on your credit card responsibilities, but if you are late on an electrical bill or a phone bill or the like, that we have seen examples where the issuers will then raise fees or rates as a result of your late payments on unrelated responsibilities, financial responsibilities. Now, it is true that, in a sense, the new rule to some degree eliminates the universal default. But under the rule, as well, and having conversations with the Fed about this, issuers can still look to off-comp behavior to increase interest rates. And so while it talks about banning it on one hand, it still tolerates the issue of actually accounting for off-balance behavior to increase rates that consumers pay. I would still call that universal default. If, in fact, the issuer can raise rates by considering these late payments in unrelated matters to the credit card, then it still seems to me that universal default exists. How do you respond to that? " FOMC20070918meeting--282 280,MR. LACKER.," Thank you, Mr. Chairman. I’ve been thinking a lot about this since I heard about it last week. I want to start by complimenting the staff at New York and the Board who wrote the summary memo. I think it does a very good and balanced job of articulating the costs and benefits of this proposed facility. I was going to say that they undoubtedly did it in a compressed timeframe, but then I heard you guys have been working on it for weeks. [Laughter] But in any event, my hat is off to them. I very much agree with the staff that weighing the costs and benefits to reach an assessment about the desirability of this is inherently a difficult judgment. For me the critical question concerns the normative implications of what we’re seeing in the marketplace for term funding and the normative implications of this proposed intervention. Banks that are borrowing at term now are paying up for insurance against the eventuality that their funding costs rise—for example, because of a deterioration in their perceived creditworthiness. Banks that have viewed themselves as more at risk are naturally willing to pay more for such insurance, and some reports suggest, as Mr. Dudley did this morning, the presence of an adverse-selection problem in the sense that borrowing at term reveals oneself to be a borrower of high risk, and so only high-risk borrowers are willing to pay more. Banks that are reluctant to lend at term are placing a high value on being able to use their liquidity to accommodate assets that may come on their balance sheet soon. We had a lot of discussion about this in the morning. Balance sheet capacity appears genuinely to be a scarce valuable commodity these days. That’s consistent with the notion that raising bank capital is expensive in the current environment. I think the adverse-selection story is worth considering seriously in this context because it’s the interpretation of what we’re seeing that provides the best hope for this being an intervention that improves market functioning in the microeconomic sense of the term. But if adverse selection is what has impaired the functioning of the term market in this normative sense, then there must be lower-risk banks that are unwilling to borrow at the same high rates as high-risk banks but that are rationed because they’re unable to distinguish themselves from high-risk banks. Now, if this is the case, the only way to improve market efficiency by lending is to lend more than the current volume of term lending because otherwise we’re just going to lend it to the current term-lending borrowers and none of these rationed-out, lower-risk banks are going to get access to it. In other words, if we do lend through an auction facility to draw in disadvantaged borrowers to try to reach them with credit, we can do so only by subsidizing the high-risk borrowers as well. Now, I’ll mention that, from the discussion this morning, my understanding is that we have very little idea what the volume of that term lending is. So I don’t see how we chose this number and how we can be confident that it’s going to do this and reach through the high-risk borrowers to pick up the low-risk borrowers. More broadly, I’m not sure I see how this facility could improve the normative functioning in the market. We’re going to auction off only the same contracts that market participants are capable of offering now, only we’re also going to subject ourselves to the additional constraints imposed by our single-price auction format. So we’re not improving on any contract out there. The only unique attribute we would appear to bring is our ability to subsidize lending terms. We could conceivably improve market functioning if adverse selection is the right story here by doing something that market participants are incapable of doing, and that would be compelling borrowing by everybody or by a set of people to achieve a superior pooling allocation. But I don’t think we want to do that. Or we could conceivably improve market functioning by acting on information that’s superior to that of market participants—a knowledge of the creditworthiness of institutions, for example. But it isn’t clear that this is a key part of the proposal either, because institutions have to be rated 3 or above to get access and I think virtually all the currently affected institutions in these sorts of high-risk and low-risk categories are in the 3 or above categories already. A related point here is that, if we really think information constraints are at the heart of the problem, it might be better to address this problem by addressing those constraints directly by using our supervisory authority to encourage and facilitate greater transparency. So my sense is that this facility would just subsidize borrowing banks without doing anything to mitigate underlying informational asymmetries or any other type of market friction that I can think of. That means to me that this proposal raises the usual moral hazard concerns. The staff memo was very clear and articulate about those. I think there’s a danger with this facility of raising expectations that, in the future, significant increases in interbank funding spreads are going to be ameliorated by central bank intervention. If we raise that expectation, we’re going to undermine to some extent market mechanisms for assessing the relative risk of institutions. I’m a little worried that if this does not produce a demonstrable effect on relevant market conditions, it could erode confidence in us, and I feel so especially in light of our previous change in discount window policy, which I think is widely viewed as having had little substantive effect so far. I think that’s the view out there. I also worry that this could complicate the resolution of failing institutions whose condition, as Vice Chairman Geithner suggested, deteriorates while they’re borrowing from this auction facility. It would put us in a very awkward place. As Governor Kohn said, this isn’t like a one-day emergency kind of thing—it takes some time. But some institutions in questionable situations, some problem institutions, look for term funding and are willing to wait four days to get it and know enough about their condition to line it up ahead of time. I worry about this sounding like a cloak for the ECB, for us to give money to the ECB, and I worry about President Rosengren’s issues as well, and I’d be more comfortable with the swap line than I am with the domestic facility. If those foreign authorities want to extend credit and have the knowledge and capacity to do so, and it’s on their dime and they’re bearing the credit risk and they want to borrow the dollars from us, I see that as a reasonable step for a central bank to take. I also worry about valuing collateral. I don’t think that our mechanisms for doing that are robust and strong, especially in the current environment with at least standard haircuts. Now, I can appreciate the broader problem articulated by the staff and others that banks that are constrained in the term funding market might tighten borrowing terms for consumers and businesses and that might have real economic consequences. But if that’s the problem, I think it would be better for us to just cut the funds rate rather than alter the relative funding costs of different banks. This is essentially what we did today. We cut the funds rate to offset the macroeconomic effects of higher credit spreads. Just a final set of comments. More broadly, I’ve been hoping for some time that banking policy in our country was moving slowly but surely toward greater reliance on market discipline and away from forbearance and subsidization. I’ve been hoping that we as a central bank would gradually move away from things that are tainted with credit allocation. Times like these don’t come around very often—you know, once a decade—and my sense is that the precedent we set here is going to be remembered for a long time and it’s going to affect market behavior for a long time to come as well. In my opinion, we ought to look at these episodes of market stress as an opportunity to make some reputational progress on the time-consistency problem that is at the heart of moral hazard. So for me the balance of considerations weighs heavily against this proposal, Mr. Chairman." CHRG-111hhrg53244--13 Mr. Bernanke," Thank you, Mr. Chairman. Chairman Frank, Ranking Member Bachus, and other members of the committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. Aggressive policy actions taken around the world last fall may well have averted the collapse of the global financial system, an event that would have had extremely adverse and protracted consequences for the world economy. Even so, the financial shocks that hit the global economy in September and October were the worst since the 1930's; and they helped push the global economy into the deepest recession since World War II. The U.S. economy contracted sharply in the fourth quarter of last year and the first quarter of this year. More recently, the pace of decline appears to have slowed significantly; and final demand and production have shown tentative signs of stabilization. The labor market, however, has continued to weaken. Consumer price inflation, which fell to low levels late last year, remain subdued in the first 6 months of 2009. To promote economic recovery and foster price stability, the Federal Open Market Committee last year brought its target for the Federal funds rate to a historically low range of zero to one-quarter percent, where it remains today. The FOMC anticipates that economic conditions are likely to warrant maintaining the Federal funds rate at exceptionally low levels for an extended period. At the time of our February report, financial markets at home and abroad were under intense strains, with equity prices at multiyear lows, risk spreads for private borrowers at very elevated levels, and some important financial markets essentially shut. Today, financial conditions remain stressed, and many households and businesses are finding credit difficult to obtain. Nonetheless, on net, the past few months have seen some notable improvements. For example, interest rate spreads and short-term money markets, such as the interbank market and the commercial paper market, have continued to narrow. The extreme risk aversion of last fall has eased somewhat, and investors are returning to private credit markets. Reflecting this greater investor receptivity, corporate bond issuance has been strong. Many markets are functioning more normally, with increased liquidity and lower bid-asked spreads. Equity prices, which hit a low point in March, have recovered to roughly their levels at the end of last year; and banks have raised significant amounts of new capital. Many of the improvements in financial conditions can be traced in part to policy actions taken by the Federal Reserve to encourage the flow of credit. For example, the decline in interbank lending rates and spreads was facilitated by the actions of the Federal Reserve and other central banks to ensure that financial institutions have adequate access to short-term liquidity, which in turn has increased the stability of the banking system and the ability of banks to lend. Interest rates and spreads on commercial paper dropped significantly as a result of the backstop liquidity facilities that the Federal Reserve introduced last fall for that market. Our purchases of agency mortgage-backed securities and other longer-term assets have helped to lower conforming fixed mortgage rates. And the Term Asset-Backed Securities Loan Facility, or TALF, which was implemented this year, has helped to restart the securitization markets for various classes of consumer and small business credit. Earlier this year, the Federal Reserve and other Federal banking regulatory agencies undertook the Supervisory Capital Assessment Program (SCARP), popularly known as the stress test, to determine the capital needs of our largest financial institutions. The results of the SCAP were reported in May, and they appear to increase investor confidence in the U.S. banking system. Subsequently, the great majority of institutions that underwent the assessment have raised equity in public markets; and, on June 17th, 10 of the largest U.S. bank holding companies, all but one of which participated in the SCAP, repaid a total of nearly $70 billion to the Treasury. Better conditions in financial markets have been accompanied by some improvements in economic prospects. Consumer spending has been relatively stable so far this year, and the decline in housing activity appears to have moderated. Businesses have continued to cut capital spending and liquidate inventories, but the likely slowdown in the pace of inventory liquidation in coming quarters represents another factor that may support a turnaround in activity. Although the recession in the rest of the world led to a steep drop in the demand for U.S. exports, this drag on our economy also appears to be waning as many of our trading partners are also seeing signs of stabilization. Despite these positive signs, the rate of job loss remains high, and the unemployment rate has continued its steep rise. Job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending. The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook. In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared economic projections covering the years 2009 through 2011. FOMC participants generally expect that, after declining in the first half of this year, output will increase slightly over the remainder of 2009. The recovery is expected to be gradual in 2010, with some acceleration in activity in 2011. Although the unemployment rate is projected to peak at the end of this year, the projected declines in 2010 and 2011 would still leave unemployment well above FOMC participants' views of the longer-run sustainable rate. All participants expect that inflation will be somewhat lower than recent years, and most expect it to remain subdued over the next 2 years. In light of the substantial economic slack and limited inflation pressures, monetary policy remains focused on fostering economic recovery. Accordingly, as I mentioned earlier, the FOMC believes that a highly accommodative stance of monetary policy will be appropriate for an extended period. However, we also believe that it is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation. The FOMC has been devoting considerable attention to issues relating to its exit strategy, and we are confident that we have the necessary tools to implement that strategy when appropriate. To some extent, our policy measures will unwind automatically as the economy recovers and financial strains ease, because most of our extraordinary liquidity facilities are priced at a premium over normal interest rate spreads. Indeed, total Federal Reserve credit extended to banks and other market participants has declined from roughly $1.5 trillion at the end of 2008 to less than $600 billion, reflecting the improvement in financial conditions that has already occurred. In addition, bank reserves held at the Fed will decline as the longer-term assets that we own mature or are prepaid. Nevertheless, should economic conditions warrant a tightening of monetary policy before this process of unwinding is complete, we have a number of tools that will enable us to raise market interest rates as needed. Perhaps the most important such tool is the authority that the Congress granted the Federal Reserve last fall to pay interest on balances held at the Fed by depository institutions. Raising the rate of interest paid on reserve balances will give us substantial leverage over the Federal funds rate and other short-term market interest rates, because banks generally will not supply funds to the market at an interest rate significantly lower than they can earn risk-free by holding balances at the Federal Reserve. Indeed, many foreign central banks use the ability to pay interest on reserves to help set a floor on market interest rates. The attraction of this to banks of leaving their excess reserve balances with the Federal Reserve can be further increased by offering banks a choice of maturities for their deposits. But interest on reserves is by no means the only tool we have to influence market rates. For example, we can drain liquidity from the system by conducting reverse repurchase agreements, in which we sell securities from our portfolio with an agreement to buy them back at later dates. Reverse repurchase agreements, which can be executed with primary dealers, Government-Sponsored Enterprises, and a range of other counterparties, are a traditional and well-understood method of managing the level of bank reserves. If necessary, another means of tightening policy is outright sales of our holdings of longer term securities. Not only would such sales drain reserves and raise short-term interest rates, but they could also put upward pressure on longer-term rates by expanding the supply of longer-term assets. In sum, we are confident that we have the tools to raise interest rates when that becomes necessary to achieve our objectives of maximum employment and price stability. Our economy and financial markets have faced extraordinary near-term challenges, and strong and timely actions to respond to those challenges have been necessary and appropriate. I have discussed some of the measures taken by the Federal Reserve to promote economic growth and financial stability. The Congress also has taken substantial actions, including the passage of a fiscal stimulus package. Nevertheless, even as important steps have been taken to address the recession and the intense threats to financial stability, maintaining the confidence of the public and financial markets requires that policymakers begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby boom generation and the continued increases in the costs of Medicare and Medicaid. Addressing the country's fiscal problems will require difficult choices, but postponing those choices will only make them more difficult. Moreover, agreeing on a sustainable long-run fiscal path now could yield considerable near-term economic benefits in the form of lower long-term interest rates and increased consumer and business confidence. Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth. A clear lesson of the recent financial turmoil is that we must make our system of financial supervision and regulation more effective, both in the United States and abroad. In my view, comprehensive reform should include at least the following key elements: a prudential approach that focuses on the stability of the financial system as a whole and not just the safety and soundness of individual institutions, and that includes formal mechanisms for identifying and dealing with emerging systemic risks; stronger capital and liquidity standards for financial firms, with more stringent standards for large, complex, and financially interconnected firms; the extension and enhancement of supervisory oversight, including effective consolidated supervision to all financial organizations that could pose a significant risk to the overall financial system; an enhanced bankruptcy or resolution regime, modeled on the current system for depository institutions, that would allow financially troubled, systemically important nonbank financial institutions to be wound down without broad disruption to the financial institution's system and to the economy; enhanced protections for consumers and investors in their financial dealings; measures to ensure that critical payment, clearing, and settlement arrangements are resilient to financial shocks, and that practices related to the trading and clearing of derivatives and other financial instruments do not pose risk to the financial system as a whole; and, finally, improved coordination across countries in the development of regulations and in the supervision of internationally active firms. The Federal Reserve has taken and will continue to take important steps to strengthen supervision, improve the resiliency of the financial system, and to increase the macroprudential orientation of our oversight. For example, we are expanding our use of horizontal reviews of financial firms to provide more comprehensive understanding of practices and risks in the financial system. The Federal Reserve also remains strongly committed to effectively carrying out our responsibilities for consumer protection. Over the past 3 years, the Federal Reserve has written rules providing strong protections for mortgage borrowers and credit card users, among many other substantive actions. Later this week, the Board will issue a proposal using our authority under the Truth in Lending Act, which will include new, consumer-tested disclosures as well as rule changes applying to mortgages and home equity lines of credit. In addition, the proposal includes new rules governing the compensation of mortgage originators. We are expanding our supervisory activities to include risk-focused reviews of consumer compliance in nonbank subsidiaries of holding companies. Our community affairs and research areas have provided support and assistance for organizations specializing in foreclosure mitigation, and we have worked with nonprofit groups on strategies for neighborhood stabilization. The Federal Reserve's combination of expertise in financial markets, payment systems, and supervision positions us well to protect the interests of consumers and their financial transactions. We look forward to discussing with the Congress ways to formalize our institution's strong commitment to consumer protection. The Congress and the American people have a right to know how the Federal Reserve is carrying out its responsibilities and how we are using taxpayer resources. The Federal Reserve is committed to transparency and accountability in its operations. We report on our activities in a variety of ways, including reports like the one I am presenting to Congress today, other testimonies, and speeches. The FOMC releases a statement immediately after each regularly scheduled meeting and detailed minutes of each meeting on a timely basis. We have increased the frequency and scope of the published economic forecast of FOMC participants. We provide the public with detailed annual reports on the financial activities of the Federal Reserve System that are audited by an independent public accounting firm. We also publish a complete balance sheet each week. We have recently taken additional steps to better inform the public about the programs we have instituted to combat the financial crisis. We expanded our Web site this year to bring together already available information as well as considerable new information on our policy programs and financial activities. In June, we initiated a monthly report to the Congress that provides even more information on Federal Reserve liquidity programs, including breakdowns of our lending, the associated collateral, and other facets of programs established to address the financial crisis. These steps should help the public understand the efforts that we have taken to protect the taxpayer as we supply liquidity to the financial system and support the functioning of key credit markets. The Congress has recently discussed proposals to expand the audit authority of the GAO over the Federal Reserve. As you know, the Federal Reserve is already subject to frequent reviews by the GAO. The GAO has broad authority to audit our operations and functions. The Congress recently granted the GAO new authority to conduct audits of the credit facilities extended by the Federal Reserve to ``single and specific'' companies under the authority provided by section 13(3) of the Federal Reserve Act, including the loan facilities provided to, or created for, AIG or Bear Stearns. The GAO and the Special Inspector General have the right to audit our TALF program, which uses funds from the Troubled Asset Relief Program. The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of Members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation and lead to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence. Thank you, Mr. Chairman. [The prepared statement of Chairman Bernanke can be found on page 68 of the appendix.] " FOMC20051101meeting--138 136,VICE CHAIRMAN GEITHNER.," We view the balance of developments since the last meeting as strengthening the case for further firming of monetary policy. The underlying pace of demand growth seems reasonably strong—a bit stronger than we thought at our last meeting. The inflation outlook to us looks largely the same as it did in September, with the expected path of core inflation higher than we would like and some risk of further acceleration. On the assumption that we increase the fed funds rate on the higher trajectory now priced into November 1, 2005 62 of 114 potential in ’06—somewhere between 3 and 3.5 percent—and for the rate of increase in the core PCE to stay in the vicinity of 2 percent. Of course, this has to be considered an implausibly benign view of the world [laughter] and the expansion still faces a familiar array of risks. But we don’t see evidence yet of a substantial slowdown in demand nor of a troubling acceleration in underlying inflation. The balance of risks in this forecast has changed a bit. I’m a little less concerned that the cumulative rise in energy prices will itself bring about a more substantial and extended slowdown in growth, although that obviously has to remain a concern and possibly the principal risk to the growth outlook. We believe that the modest expected tightening of financial conditions will have less of a dampening effect on demand growth than the Greenbook assumes. We don’t see strong evidence yet of a significant deceleration in housing price appreciation or expectations of that outcome in household spending behavior, although both would be desirable. The evidence of strong stability in the growth of household consumption is, in a sense, borrowing against a future cushion, and that perhaps raises the probability of a more adverse path to future consumption. But it’s not here yet. As in September, the relative probabilities of alternative inflation outcomes still seem slightly skewed to the upside, thus probably justifying more cumulative firming in monetary conditions. Core PCE has remained moderate, compensation growth modest, productivity growth strong, and long-term inflation expectations reassuringly low. But the size of the rise in headline inflation and the deterioration in near-term expectations creates the possibility of some further drift up in underlying inflation if, as we expect, the labor market firms further and unit labor costs eventually start to rise more rapidly. We’re seeing some drift upward in core inflation outside of the United November 1, 2005 63 of 114 On balance, to us this suggests we need to make sure that the market remains confident we’ll do enough to bring inflation and inflation expectations down over the next two years. To put it differently, we should make sure that we take out enough insurance to avoid a more adverse inflation outcome, and in this sense we should be pleased that the market has raised its estimate of the terminal fed funds rate to around 4½ percent. Our statement today, I believe, should be designed to be neutral to those expectations, rather than to raise or lower the expected path. I do think it would be helpful if the minutes reflected some discussion today about the approaching need—the approaching need, not the need today—for some changes in the structure of the statement. We’ve been very fortunate to date in how well we have managed this transition in monetary policy, with the market expecting a sustained period of tightening but its expectation of the terminal fed funds rate varying with changes in the outlook. Our decision to put a soft, qualified, conditional ceiling on the fed funds rate path at 25 basis points a meeting has not cost us to date any erosion in long-term credibility, though it probably has encouraged the market’s investors to take more duration risk. The remarkable stability in quarterly GDP growth and in core inflation we’ve seen has tended to reinforce expectations about the outlook for monetary policy, adding an unusual degree of certainty about the likely path of the fed funds rate. This has to change. As we become less certain about the path ahead, that increase in uncertainty needs to get built into market expectations. The question is when and how we alter our statement to reflect this. So far, the dominant strategy before us has been to keep moving 25 basis points, to signal that we will continue to do so, and to defer any major changes to the structure of the statement until we are confident we have made our last move. Now, this may turn out to be the optimal choice, but the language feels increasingly stale. And it may be better, in fact, to change the November 1, 2005 64 of 114 might make the transition ahead more gentle. It would give us more than one shot at recalibrating the signal, and it might help bring the market’s uncertainty about what’s ahead more in line with our own. There are two areas where changes in the statement seem indicated. The first is in how we characterize the rationale for our action. There we have some room to become more explicit about our view of the outlook relative to our objectives without going all the way to a fully articulated, quantitative forecast. The second, of course, is in the end of the statement. If the world in December looks about how it looks now, with a high probability of one or more moves still ahead of us, we could, for example, replace the last three sentences of the statement with two which state our views more simply. They would state first that the outlook for growth and inflation suggests that further monetary policy firming is likely to be necessary, and, second, that the Committee will respond to changes in economic prospects as needed to maintain price stability so as to achieve sustainable growth. This would get us out of some of the risks of repeating “measured” going forward. It would help address some of the problems in using the word “accommodation” to signal tightening. And it would eliminate the awkwardness in the superfluous balance of risk sentence we now have. This would allow an easy evolution to a more neutral signal when that becomes appropriate—with a simple statement that policy is now roughly appropriate but that we will act as necessary to achieve our objectives going forward. Of course, the world may look different in December, and we have to assess then what makes the most sense. I don’t know that we can say with confidence today that evolution in December is ideal or necessary, but I think we need to prepare ourselves and the markets for some evolution. November 1, 2005 65 of 114" CHRG-111shrg62643--46 Mr. Bernanke," I don't think it is really my place to tell Congress which specific tax and spending policies to choose. I prefer to address the broader trajectory of fiscal stimulus. Senator Reed. Well, the trajectory would be made better or worse if those provisions were extended without condition? " CHRG-111hhrg46820--115 Mr. Seiffert," Sure. And it goes back to the issue of unserved communities and communities that the economics don't work as well in the larger market. And so a public-private partnership is one way to get around the market conditions and make sure that companies can get a return on that investment. And so we support that. " CHRG-110hhrg44903--179 Mr. Geithner," You have the ability to come and borrow from the Fed under a set of conditions. And that privilege existed before Katrina, before Bear Stearns. It exists today. Ms. Waters. Did any of the banks who had been impacted by Katrina take advantage of the opportunity to borrow from the discount window? " FOMC20080310confcall--28 26,MR. LOCKHART.," Thank you, Mr. Chairman. The question relates to what President Fisher was pursuing, which, if I understand correctly, is our chance of actually incurring a loss in holding the less creditworthy paper. That would relate to a default on the part of a broker�dealer in unwinding the swap and then an ultimate loss in how we dispose of the paper over time if we were to hold it. So the question is, Are we aware of any primary dealers who are really in serious condition at this stage and constitute a ""first way out"" risk? " CHRG-111shrg54675--83 PREPARED STATEMENT OF FRANK MICHAEL President and Chief Executive Officer, Allied Credit Union, Stockton, California, On Behalf of the Credit Union National Association July 8, 2009 Chairman Johnson, Ranking Member Crapo, and Members of the Financial Institutions Subcommittee, thank you very much for the opportunity to testify at today's hearing on ``The Effects of the Economic Crisis on Community Banks and Credit Unions in Rural Communities'' on behalf of the Credit Union National Association (CUNA). CUNA is the Nation's largest credit union advocacy organization, representing over 90 percent of our Nation's approximately 8,000 State and Federal credit unions, their State credit union leagues, and their 92 million members. My name is Frank Michael, and I am President and CEO of Allied Credit Union in Stockton, California. Allied Credit Union is a small institution with $20 million in assets and approximately 2,600 member-owners. Originally my credit union's field of membership was limited to Greyhound bus drivers but it has grown to include employees served by a variety of labor union locals, those who live, work, worship, or attend school in the incorporated and unincorporated areas of Stockton, California, and employees of a number of companies outside of Stockton proper. I also serve as Chair of CUNA's Small Credit Union Committee--which is charged with monitoring issues affecting small credit unions that operate in both urban and rural settings. I am honored to be here to speak to you about the present state of small credit unions in rural communities, the obstacles these institutions are encountering, and the effects of recent legislation on these institutions.Credit Unions Stand Apart From Other Financial Institutions I would like to emphasize that while I am here to represent the views of ``small'' credit unions, credit unions are generally very small by banking industry standards: The average credit union has roughly $110 million in total assets whereas the average banking institution is 15 times larger with $1.7 billion in total assets. \1\ (The median size credit union has just $15 million in total assets and the median size bank is about 10 times larger with $146 million in total assets).--------------------------------------------------------------------------- \1\ Financial data is as of March 2009. Credit union data is from the NCUA, bank data is from the FDIC.--------------------------------------------------------------------------- It is also important to stress that credit unions--rural, urban, large, and small--did not contribute to the subprime meltdown or the subsequent credit market crisis. Credit unions are careful lenders. And, as not-for-profit membership cooperatives the overriding operating objective at credit unions is to maximize member service. Incentives at credit unions are aligned in a way that ensures little or no harm is done to the member-owners. As we have seen, the incentives outside of the credit union sector are aligned in a way that can (and often does) cause harm to consumers. In the case of toxic mortgages such as subprime mortgages, entities operating outside of the cooperative sector focused on maximizing loan originations (specifically fee income from those originations) even though many of the loans originated were not in the borrower's best interest. Further, credit unions hold most of their loans in portfolio. In recent years, 70 percent of credit union mortgage originations have been held in portfolio--only 30 percent have been sold into the secondary market. In the broader credit union loan portfolio the percentage held is even higher. The maintenance of this ownership interest means that credit unions care deeply about what ultimately happens to the loans they originate--they care if the loans are paid back. The subprime crisis, in contrast, has been closely linked to lenders who adopted the originate-to-sell model. These lenders cared little about repayments because the quality of the loans they sold became someone else's problem. In the end these structural and operational differences translated into high asset quality at credit unions. \2\ Annualized first quarter 2009 net charge-offs at credit unions were equal to 1.11 percent of average loans outstanding. In the same period, banking industry net charge-offs were 1.94 percent.--------------------------------------------------------------------------- \2\ High credit union asset quality is doubly impressive given the exemplary record of credit union success in serving those of modest means. For example, credit union mortgage loan delinquency and chargeoff rates are very low compared to other lenders. At the same time Home Mortgage Disclosure Act (HMDA) statistics consistently show that lower income and minority borrowers in the market for mortgages are substantially more likely to be approved for a loan at a credit union. HMDA data also shows that compared to other lenders, a greater percentage of total credit union home loans are granted to low/moderate income consumers.--------------------------------------------------------------------------- Delinquency rates--a forward-looking indicator of credit quality also highlights the credit union difference. As of March 2009, 60+ day dollar delinquency rates on credit union loans were 1.44 percent. In contrast the banking industry's 90+ day dollar delinquency rate was 3.88 percent--over two-and-one-half times higher than the credit union norm despite an additional 30 days of collection efforts. High asset quality helped to keep credit union capital ratios near record levels. At the end of March 2009 the aggregate credit union net worth ratio was 10 percent--substantially higher than the 7 percent regulatory standard that institutions need to be considered ``well capitalized.'' Strong asset quality and high capital kept most credit unions ``in the game'' while the other lenders pulled back and significantly tightened loan underwriting standards. Overall, loan growth rates at credit unions have remained comparatively high. In the year ending March 2009, credit union loans grew by 6 percent--a rate of increase that is well above the 2 percent to 3 percent growth credit unions usually see in consumer-led recessions and a stark contrast to the 3 percent decline in bank loans over the same timeframe. Real estate loans at credit unions grew by nearly 9 percent in the year ending March 2009, while banking industry real estate loans declined by approximately 2 percent. Business loans at credit unions grew by nearly 16 percent in the year ending March 2009, whereas commercial loans at banking institutions declined by 3 percent. Importantly, credit union pricing continues to reflect a strong, long-standing consumer-friendly orientation. According to Datatrac, a national financial institution market research company, credit union average loan rates have remained far lower than those in the banking arena and credit union average yields on savings accounts have remained far higher than those in the banking arena. The pricing advantage to credit union members is evident on nearly every account that Datatrac measures. In the aggregate, CUNA economists estimate that the credit union pricing advantage saved credit union members $9.25 billion in 2008 alone. \3\ This makes a significant difference to tens of millions of financially stressed consumers throughout the Nation.--------------------------------------------------------------------------- \3\ This estimate does not include the procompetitive effects credit union pricing has on banking institutions. Several recent studies indicate that the credit union presence causes other institutions to price in a more consumer-friendly fashion, saving consumers several billions of dollars annually. See Feinberg (2004) and Tokel (2005).--------------------------------------------------------------------------- While credit unions have generally fared well, they are not immune from the effects of the financial crisis. Of course, the ``too-big-to-fail'' issue roils many small credit unions, including those operating in rural areas. In addition, there are some natural person credit unions, especially in States such as California, Florida, Arizona, Nevada, and Michigan that are experiencing serious financial stresses, including net worth strains, primarily as a result of the collateral effects of their local economic environments. Within the credit union system, the corporate credit union network has been particularly hard hit as credit market dislocations saddled several of these institutions with accounting losses on mortgage-backed and asset-backed securities. There are currently 28 corporate credit unions, which are owned by their natural person credit union members. Corporate credit unions are wholesale financial institutions that provide settlement, payment, liquidity, and investment services to their members. The powers of corporate credit unions differ from natural person credit unions. For example, the mortgage backed and asset backed securities that are permissible investments for corporate credit unions and not generally permissible for natural person credit unions. For the most part, the problematic securities were tripled-A rated at the time the corporate credit unions purchased them. However, as a result of the impact of the economy on the securities, and the mortgages and other assets underlying the securities, the National Credit Union Administration (NCUA) has projected substantial credit losses relating to these securities. The recently enacted, ``Helping Families Save Their Homes Act of 2009'' gave NCUA additional tools with which to assist credit unions in dealing with costs related to Corporate Credit Union stabilization actions. We applaud the Banking Committee's leadership on that issue, and thank Congress for acting expeditiously to address these concerns. These stabilization efforts permit credit unions to continue to provide high levels of membership service while reducing the immediate financial impact on credit unions and ensuring the maintenance of a safe and strong Nation Credit Union Share Insurance Fund.Rural Credit Unions Are Playing a Vital Role in the Economic Recovery Rural credit unions are unique in many respects. \4\ There are nearly 1,500 U.S. credit unions with a total of $60 billion in assets headquartered in rural areas. These institutions represent 19 percent of total credit unions and 7 percent of total U.S. credit union assets.--------------------------------------------------------------------------- \4\ For purposes of this analysis ``rural'' areas are defined as non-MSA counties, consistent with OMB definitions. This definition includes 64 percent of U.S. counties and 16 percent of the total U.S. population. Of course, many credit unions that are headquartered in urban areas have branches in rural areas. These institutions are not included in our analysis because financial results are not available at the branch level.--------------------------------------------------------------------------- Rural credit unions tend to be small--even by credit union standards. On average, rural credit unions have just $39 million in total assets (making them about one-third the size of the average U.S. credit union and one-fortieth the size of the average U.S. banking institution.) In addition, nearly one-quarter (23 percent) of rural credit unions operate with one or fewer full-time equivalent employee. Over half (54 percent) of rural credit unions are staffed by five or fewer full-time equivalent employees. These differences mean that even in good times, rural credit unions tend to face challenges in a way that larger credit unions do not. Pressures on the leaders of these small credit unions are great because they must be intimately involved in all aspects of credit union operations. Their small size, without the benefits of economies of scale, magnifies the challenges they face. Competitive pressures from large multistate banks and nontraditional financial services providers each increasingly provide substantial challenges. Greater regulatory burdens, growing member sophistication, loss of sponsors, and difficulties in obtaining training and education also loom large for most of the Nation's small credit unions. A bad economy can make things even worse. Small credit unions have very close relationships with their members. And member needs increase dramatically during recessions: They experience more personal financial difficulty; job losses mount; retirement funds dwindle; debt loads balloon; divorce rates rise. Small institutions come under tremendous pressure as they attempt to advise, consult with, and lend to these members. Despite these substantial hurdles rural credit unions are posting comparatively strong results: Their loan and savings growth rates are nearly identical to the national credit union norms. Their delinquency rates are nearly identical to the national average and their net chargeoff rates are about one-half the national credit union norm. They posted earnings declines, but also reflected stronger earnings results and report higher net worth ratios than the national credit union averages.Rural Credit Unions Face Growing Concerns Although small, rural credit unions are relatively healthy and continue to play a vital role in the Nation's economic recovery, that role is being threatened. There are several concerns raised by small credit unions--and rural credit unions in particular--that deserve mention.Regulatory Burden and Reregulation. The credit union movement is losing small institutions at a furious pace--about one per day. Many of these are rural credit unions. The rate of decline does not seem to be slowing and most observers expect the pace to accelerate. The declines do NOT reflect failures but arise from voluntary mergers of small institutions into larger institutions. If you ask small institutions, they will tell you that one of the larger contributors to this consolidation is the smothering effect of the current regulatory environment. Small credit union operators believe that the regulatory scrutiny they face is inconsistent with both their exemplary behavior in the marketplace and with the nearly imperceptible financial exposure they represent. A large community of small credit unions, free of unnecessary regulatory burden, benefits the credit union movement, the public at large and especially our rural communities. As the Subcommittee considers regulatory restructuring proposals, we strongly urge you to continue to keep these concerns in the forefront of your decision making. Moreover, we implore you to look for opportunities to provide exemptions from the most costly and time-consuming initiatives to cooperatives and other small institutions. Both the volume of rules and regulations as well as the rate of change in those rules and regulations are overwhelming--especially so at small institutions with limited staff resources. Additionally, rural credit unions, like all credit unions, play ``by the rules.'' Yet, they correctly worry that they will be forced to pay for the sins of others and that they will be saddled with heavy additional burdens as efforts to reregulate intensify. Nevertheless, while others in the financial services community call for the Administration to back down on plans to create a separate Consumer Financial Protection Agency (CFPA), CUNA President and CEO Dan Mica met with Treasury Secretary Geithner last week to discuss the administration's financial regulatory overhaul legislation. In that meeting, Mr. Mica signaled our willingness to work with the administration and Congress, to maintain a seat at the table and to continue the conversation to obtain workable solutions. Credit union member-ownership translates to a strong proconsumer stance but that stance must be delicately balanced with the need keep our member-owned institutions an effective alternative in the marketplace. Of course, any new legislation and regulation comes with possibility of unintended consequences, and credit unions are particularly sensitive to the unintended consequences of otherwise well-intentioned legislation, especially given an issue that has arisen with respect to the Credit Card Accountability Responsibility and Disclosure Act (CARD Act).Credit Card Accountability, Responsibility and Disclosure Act CUNA supports the intent of the CARD Act to eliminate predatory credit card practices. Although it will require some adjustments in credit card programs in the next 6 weeks to provide a change-in-terms notice 45 days in advance and to require periodic statements to be mailed at least 21 days in advance before a late charge can be assessed, CUNA supports these provisions and credit unions are diligently working with their data processors to effectuate these changes by the August 20, 2009, effective date. However, Section 106 of the CARD Act also requires, effective August 20, 2009, that the periodic statements for all open-end loans--not just credit card accounts--be provided at least 21 days before a late charge can be assessed. This means that a creditor must provide periodic statements at least 21 days in advance of the payment due date in order to charge a late fee. Open-end loans include not only credit cards, but also lines of credit tied to share/checking accounts, signature loans, home equity lines of credit, and other types of loans where open-end disclosures are permitted under Regulation Z, the implementing regulations for the Truth in Lending Act. We believe extending the requirements of this provision beyond credit cards was unintended, and ask Congress to encourage the Federal Reserve Board to postpone the effective date of this provision. If this provision is not postponed and considered further, the implementation of this provision will impose a tremendous hardship on credit unions. Simply put, we do not think credit unions can dismantle and restructure open-end lending programs they have used for decades in order to meet the August 20th deadline. By way of background, this provision appeared for the first time in the Senate manager's amendment to H.R. 627. The House-passed bill only applied the 21-day requirement to credit cards and was to be effective in 2010. During the Senate's consideration of this issue, the 21-day requirement was described as applying only to credit cards. \5\ In the weeks since enactment, many began to notice that the provision was not limited to credit card accounts and wondered if it was a drafting error. The confusion over this provision continues, as evidenced by the fact that as recently as June 25, the Office of Thrift Supervision released a summary of the CARD Act which states that the 21-day rule only applies to credit cards. \6\--------------------------------------------------------------------------- \5\ Remarks of Senator Dodd during consideration of S. Amdt. 1058 to H.R. 627. Congressional Record. May 11, 2009, S5314. \6\ http://files.ots.gslsolutions.com/25308.pdf.--------------------------------------------------------------------------- There is a great deal of uncertainty about this particular provision, which makes it quite understandable that creditors may not even know about the ramifications of this new provision and the changes they need to have in place in 6 weeks. This provision creates unique issues for credit unions because of their membership structure; as you know, credit unions serve people within their fields of membership who choose to become members. Because of this membership relationship, most credit unions provide monthly membership statements which combine information on a member's savings, checking and loan accounts other than for credit cards. For almost 40 years--since the implementation of Regulation Z--credit unions have been authorized to use multifeatured open-end lending programs that allow credit unions to combine an array of loan products and provide open-end disclosures for compliance purposes. Today, almost half of the Nation's credit unions--about 3,500 credit unions--use these types of open-end programs, which can include as open-end lending products loans secured by automobiles, boats, etc. CUNA is still trying to determine the full impact of the new law if credit unions will have to provide a 21-day period before the payment due date of all open-end loan products. Here are some preliminary compliance problems we have identified: 1. Credit unions will need to consider discontinuing the use of consolidated statements, something they cannot possibly do in the next 6 weeks, because different loans on the statements often have different due dates. 2. In order to comply with the 21-day mailing period, credit union members will no longer be able to select what day of the month they want designate as their due date for their automobile payments, a practice often allowed by credit unions, and no longer may be able to have biweekly payments to match repayments with biweekly pay checks, which helps members to budget. 3. Credit unions may have to discontinue many existing automated payment plans that will fail to comply with the 21-day requirement and work with members to individually work out new plans in order to comply with the law. 4. The 21-day requirement as it applies to home equity lines of credit (HELOCs) may raise contractual problems that cannot be easily resolved. These complicated changes simply cannot be executed within the next 6 weeks, and CUNA requests that Congress urge Federal Reserve Board to limit the August 20 effective date to the two credit card provisions in Section 106, at least for credit unions.Credit Union Lending to Small Businesses As noted above, credit unions have been able to ``stay in the game'' while other lenders have pulled back. The credit crisis that many small businesses face is exacerbated by the fact that credit unions are subject to a statutory cap on the amount of business lending they can do. This cap--which is effectively 12.25 percent of a credit union's total assets--was imposed in 1998, after 90 years of credit unions offering these types of loans to their members will no significant safety and soundness issues. CUNA believes that the greater the number of available sources of credit to small business, the more likely a small business can secure funding and contribute to the Nation's economic livelihood. Currently, 26 percent of all rural credit unions offer member business loans to their members. These loans represent over 9 percent of total loans in rural credit union portfolios. In contrast member business loans account for less than 6 percent of total loans in the movement as a whole. Total member business loans at rural credit unions grew by over 20 percent in the year ending March 2009, with agricultural MBLs increasing by over 12 percent and Non-Ag MBLs increasing 26 percent in the 12 month period. This is strong evidence that rural credit unions remain ``in the game'' during these trying times. But more could be done. And more should be done. A chorus of small business owners complains that they can't get access to credit. Federal Reserve surveys show that the Nation's large banks tightened underwriting standards for the better part of the past year. In 2005, an SBA research publication noted that large bank consolidation is making it more difficult for small businesses to obtain loans. \7\ Given the fact that the average size of a credit union member business loan is approximately $216,000 this is a market that credit unions are well suited to serve. And this is a market that credit unions are eager to serve.--------------------------------------------------------------------------- \7\ Small Business Administration. The Effects of Mergers and Acquisitions on Small Business Lending by Large Banks. March 2005.--------------------------------------------------------------------------- Chairman Johnson, you undoubtedly hear a lot of rhetoric surrounding credit union member business lending. However, please allow me to paint a more complete picture of the member business loan (MBL) activity of credit unions. Member business loans that credit unions provide their members are relatively small loans. Nationally, credit union business lending represents just over one percent (1.06 percent) of the depository institution business lending market; credit unions have about $33 billion in outstanding business loans, compared to $3.1 trillion for banking institutions. \8\ In general, credit unions are not financing skyscrapers or sports arenas; credit unions are making loans to credit union members who own and operate small businesses.--------------------------------------------------------------------------- \8\ All financial data is March 2009. Credit union data is from NCUA; Bank data is from FDIC.--------------------------------------------------------------------------- Despite the financial crisis, the chief obstacle for credit union business lending is not the availability of capital--credit unions are, in general, well capitalized. Rather, the chief obstacle for credit unions is the arbitrary statutory limits imposed by Congress in 1998. Under current law, credit unions are restricted from member business lending in excess of 12.25 percent of their total assets. This arbitrary cap has no basis in either actual credit union business lending or safety and soundness considerations. Indeed, a subsequent report by the U.S. Treasury Department found that business lending credit unions were more regulated than other financial institutions, and that delinquencies and charge-offs for credit union business loans were ``much lower'' than that for either banks or thrift institutions. \9\--------------------------------------------------------------------------- \9\ United States Department of Treasury, ``Credit Union Member Business Lending.'' January 2001.--------------------------------------------------------------------------- The statutory cap on credit union member business lending restricts the ability of credit unions offering MBLs from helping their members even more, and discourages other credit unions from engaging in business lending. The cap is a real barrier to some credit unions establishing an MBL program at all because it is costly to create an MBL program and it is easy to reach the cap in fairly short order--this is especially true for small rural institutions. The cap effectively limits entry into the business lending arena on the part of small- and medium-sized credit unions because the startup costs and requirements, including the need to hire and retain staff with business lending experience, exceed the ability of many credit unions with small portfolios to cover these costs. For example, the average rural credit union that does not now engage in business lending has $17 million in average assets. At the institution level, that translates to roughly $2 million in MBL authority which, in turn translates to an average of only nine loans. The cap is overly restrictive and undermines public policy to support America's small businesses. It severely restricts the ability of credit unions to provide loans to small businesses at a time when small businesses are finding it increasingly difficult to obtain credit from other types of financial institutions, especially larger banks. Today, only one in four credit unions have MBL programs and aggregate credit union member business loans represent only a fraction of the commercial loan market. Eliminating or expanding the limit on credit union member business lending would allow more credit unions to generate the level of income needed to support compliance with NCUA's regulatory requirements and would expand business lending access to many credit union members, thus helping local communities and the economy. While we support strong regulatory oversight of how credit unions make member business loans, there is no safety and soundness rationale for the current law which restricts the amount of credit union business lending. There is, however, a significant economic reason to permit credit unions to lend without statutory restriction, as they were able to do prior to 1998: America's small businesses need the access to credit. As the financial crisis has worsened, it has become more difficult for small businesses to get loans from banks, or maintain the lines of credit they have had with their bank for many years. A growing list of small business and public policy groups agree that now is the time to eliminate the statutory credit union business lending cap, including the Americans for Tax Reform, the Competitive Enterprise Institute, the Ford Motor Minority Dealer Association, the League of United Latin American Citizens, the Manufactured Housing Institute, the National Association for the Self Employed, the National Association of Mortgage Brokers, the National Cooperative Business Association, the National Cooperative Grocers Association, the National Farmers Union, the National Small Business Association, the NCB Capital Impact, and the National Association of Professional Insurance Agents. We hope that Congress will eliminate the statutory business lending cap entirely, and provide NCUA with authority to permit a CU to engage in business lending above 20 percent of assets if safety and soundness considerations are met. We estimate that if the cap on credit union business lending were removed, credit unions could--safely and soundly--provide as much as $10 billion in new loans for small businesses within the first year. This is economic stimulus that would not cost the taxpayers a dime, and would not increase the size of government.Conclusion In closing, Chairman Johnson, Ranking Member Crapo, and all the Members of this Subcommittee, we appreciate your review of these issues today. Every day, credit unions reinforce their commitment to workers, small business owners, and a host of others in rural communities seeking to better their quality of life by providing loans on terms they can afford and savings rates that are favorable. We look forward to working with you to ensure the credit union system continues to be an important bulwark for the 92 million individuals and small businesses that look to their credit union for financial strength and support. ______ CHRG-111shrg57320--365 Mr. Corston," Essentially, we would be looking at the level of risk and the direction of risk. So when we are looking at this report, it has moderate to high credit risk that is increasing in nature. And I think if you go through the reports, you will see that the mitigants for higher levels of credit risk, such as risk practices and things like that, were not apparent in this institution. That was a concern. And this is one of the reasons that access to clearer information for the FDIC in that situation was more critical. Senator Levin. Just to make sure I understand that, that is why--what you just said is the access to their information---- " CHRG-111shrg52619--192 RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM MICHAEL E. FRYZELQ.1. It is clear that our current regulatory structure is in need of reform. At my subcommittee hearing on risk management, March 18, 2009, GAO pointed out that regulators often did not move swiftly enough to address problems they had identified in the risk management systems of large, complex financial institutions. Chair Bair's written testimony for today's hearing put it very well: `` . . . the success of any effort at reform will ultimately rely on the willingness of regulators to use their authorities more effectively and aggressively.'' My questions may be difficult, but please answer the following: If this lack of action is a persistent problem among the regulators, to what extent will changing the structure of our regulatory system really get at the issue?A.1. For the most part, the credit unions have not become large, complex financial institutions. By virtue of their enabling legislation along with regulations established by the NCUA, federal credit unions are more restricted in their operation than other financial institutions. For example, investment options for federal credit unions are largely limited to U.S. debt obligations, federal government agency instruments, and insured deposits. Federal credit unions cannot invest in a diverse range of higher yielding products, including commercial paper and corporate debt securities. Another example of restrictions in the credit union industry includes the affiliation limitations. Federal credit unions are much more limited than other financial institutions in the types of businesses in which they engage and in the kinds of affiliates with which they deal. Federal credit unions cannot invest in the shares of an insurance company or control another financial depository institution. Limitations such as these have helped the credit union industry weather the current economic downturn. These limitations among the other unique characteristics of credit unions make credit unions fundamentally different from other forms of financial institutions and demonstrate the need to ensure their charter is preserved in order to continue to meet their members' financial needs. Restructuring the regulatory system to include a systemic regulator would add a level of checks and balances to the system to address the issue of regulators using their authorities more effectively and aggressively. The systemic regulator should be responsible for establishing general safety and soundness guidelines for financial institutions and then monitoring the financial regulators to ensure these guidelines are implemented. This extra layer of monitoring would help ensure financial regulators effectively and aggressively address problems at hand.Q.2. Along with changing the regulatory structure, how can Congress best ensure that regulators have clear responsibilities and authorities, and that they are accountable for exercising them ``effectively and aggressively''?A.2. If a systemic regulator is established, one of its responsibilities should include monitoring the implementation of the established safety and soundness guidelines. This monitoring will help ensure financial regulators effectively and aggressively enforce the established guidelines. The oversight entity's main functions should be to establish broad safety and soundness principles and then monitor the individual financial regulators to ensure the established principles are implemented. This structure also allows the oversight entity to set objective-based standards in a more proactive manner, and would help alleviate competitive conflict detracting from the resolution of economic downturns. This type of structure would also promote uniformity in the supervision of financial institutions while affording the preservation of the different segments of the financial industry, including the credit union industry. Financial regulators should be encouraged to aggressively address areas of increased risk as they are discovered. Rather than financial institution management alone determining risk limits, financial regulators must take administrative action when the need arises. Early recognition of problems and implementing resolutions will help ensure necessary actions are taken earlier rather than later. In addition, financial regulators should more effectively use off-site monitoring to identify and then increase supervision in areas of greater risk within the financial institutions.Q.3. How do we overcome the problem that in the boom times no one wants to be the one stepping in to tell firms they have to limit their concentrations of risk or not trade certain risky products? What thought has been put into overcoming this problem for regulators overseeing the firms?A.3. There is a need to establish concentration limits on risky products. NCUA already has limitations in place that have helped the credit union industry avoid some of the issues currently faced by other institutions. For example: Federal credit unions' investments are largely limited to United States debt obligations, federal government agency instruments, and insured deposits. \2\ Federal credit unions cannot invest in a diverse range of higher yielding products, including commercial paper and corporate debt securities. Also, federal credit unions have limited authority for broker-dealer relationships. \3\--------------------------------------------------------------------------- \2\ NCUA Rules and Regulations Part 703. \3\ NCUA Rules and Regulations Part 703. Federal credit unions are much more limited than other financial institutions in the types of businesses in which they engage and in the kinds of affiliates with which they deal. Federal credit unions cannot invest in the shares of an insurance company or control another financial depository institution. Also, they cannot be part of a financial services holding company and become affiliates of other depository institutions --------------------------------------------------------------------------- or insurance companies. Unlike other financial institutions, federal credit unions cannot issue stock to raise additional capital. \4\ Also, federal credit unions have borrowing authority limited to 50 percent of paid-in and unimpaired capital and surplus. \5\--------------------------------------------------------------------------- \4\ 12 U.S.C. 1790d(b)(1)(B)(i). \5\ 12 U.S.C. 1757(9). Sound decision making should always take precedence over following the current trend. The addition of a systemic regulator would provide the overall monitoring for systemic risk that should be limited. The systemic regulator would then establish principles-based regulations for the financial regulators to implement. This would provide checks and balances to ensure regulators were addressing the issues identified. The systemic regulator should be charged with monitoring and implementing guidelines for the systemic risks to the industry, while the financial regulators would supervise the financial institutions and implement the guidelines established by the systemic regulator. Since the systemic regulator only has oversight over the financial regulators, they would not have direct supervision of the financial institutions. This buffer would help overcome the issue of when limits should be ---------------------------------------------------------------------------implemented.Q.4. Is this an issue that can be addressed through regulatory restructure efforts?A.4. As stated above, the addition of a systemic regulator would help address these issues by providing a buffer between the systemic regulator establishing principles-based regulations and the financial regulators implementing the regulations. The addition of the systemic regulator could change the approach of when and how regulators address areas of risk. The monitoring performed by the systemic regulator would help ensure the financial regulators were taking a more proactive approach to supervising the institutions for which they are responsible.Q.5. As Mr. Tarullo and Mrs. Bair noted in their testimony, some financial institution failures emanated from institutions that were under federal regulation. While I agree that we need additional oversight over and information on unregulated financial institutions, I think we need to understand why so many regulated firms failed. Why is it the case that so many regulated entities failed, and many still remain struggling, if our regulators in fact stand as a safety net to rein in dangerous amounts of risk-taking?A.5. While regulators are a safety net to guard against dangerous amounts of risk taking, the confluence of events that led to the current level of failures and troubled institutions may have been beyond the control of individual regulators. While many saw the risk in lower mortgage loan standards and the growth of alternative mortgage products, the combination of these and the worst recessionary conditions and job losses in decades ended with devastating results to the financial industry. Exacerbating this combination was the layering of excess leverage that built over time, not only in businesses and the financial industry, but also in individual households. In regards to the credit union industry's record in the current economic environment, 82 federally insured credit unions have failed in the past 5 years (based on the number of credit unions causing a loss to the National Credit Union Share Insurance Fund). Overall, federally insured credit unions maintained reasonable financial performance in 2008. As of December 31, 2008, federally insured credit unions maintained a strong level of capital with an aggregate net worth ratio of 10.92 percent. While earnings decreased from prior levels due to the economic downturn, federally insured credit unions were able to post a 0.30 percent return on average assets in 2008. Delinquency was reported at 1.37 percent, while net charge-offs was 0.84 percent. Shares in federally insured credit unions grew at 7.71 percent, with membership growing at 2.01 percent, and loans growing at 7.08 percent. \6\--------------------------------------------------------------------------- \6\ Based on December 31, 2008, Call Report (NCUA Form 5300) data.Q.6. While we know that certain hedge funds, for example, have ---------------------------------------------------------------------------failed, have any of them contributed to systemic risk?A.6. As the NCUA does not regulate or oversee hedge funds, it is not within our scope to be able to comment on the impact of failed hedge funds and whether or not those failures contributed to systemic risk.Q.7. Given that some of the federal banking regulators have examiners on-site at banks, how did they not identify some of these problems we are facing today?A.7. NCUA does not have on-site examiners in natural person credit unions. However, as a result of the current economy, NCUA has shortened the examination cycle to 12 months versus the prior 18 months schedule. NCUA also performs quarterly reviews of the financial data submitted to the agency by the credit union. NCUA does have on-site examiners in some corporate credit unions. Natural person credit unions serve members of the public, whereas corporate credit unions serve the natural person credit unions. On March 20,2009, NCUA placed two corporate credit unions into conservatorship, due mainly to the decline in value of mortgage backed securities held on their balance sheets. Conventional evaluation techniques did not sufficiently identify the risks of these newer structured securities or the insufficiency of the credit enhancements that supposedly protected the securities from losses. NCUA's evaluation techniques did not fully keep pace with the speed of change in the structure and risk of these securities. Additionally, much of the information obtained by on-site examiners is provided by the regulated institutions. These institutions may become less than forthcoming in providing negative information when trends are declining. NCUA is currently evaluating the structure of the corporate credit union program to determine what changes are necessary. NCUA is also reviewing the corporate credit union regulations and will be making changes to strengthen these entities. ------ FOMC20080310confcall--2 0,CHAIRMAN BERNANKE.," Good evening, everybody. I am sorry, once again, to have to call you together on short notice. We live in a very special time. We have seen, as you know, significant deterioration in term funding markets and more broadly in the financial markets in the last few days. Some of this is credit deterioration, certainly, given increased expectations of recession; but there also seem to be some self-feeding liquidity dynamics at work as well. So the question before us is whether there are actions we can take, other than monetary policy, to break or mitigate this adverse dynamic. There are two actions on the table, which I think we should just try to consider together, if possible. The first is the proposed term securities lending facility--I know you received the documentation on this without much notice, but we will get some explanation in the meeting. The second item--we have received formal requests from the European Central Bank (ECB) and from the Swiss National Bank (SNB) to expand and extend the currency swap lines that we have with them. As you recall, in December we had a coordinated action, which involved the ECB and the SNB doing dollar funding auctions that piggybacked on our term auction facility. They stopped doing that after the turn of the year, but they would like to return to doing that now for some time. They think that dollar funding conditions warrant it. They are requesting that we raise their swap lines. The ECB's line is currently $20 billion. It would like to raise its line to $30 billion, so it can do two $15 billion auctions a month. The Swiss National Bank would like to have its $4 billion line raised to $6 billion, so it can do one $6 billion auction each month. That would be a coordinated effort. We would have a joint statement, along with the United Kingdom and Canada, and also supporting statements from Sweden and Japan. So it would be a type of coordination similar to the one we saw in December. Again, the request is to increase the swap lines and to extend them, and we propose to extend them through September 30. That requires a vote of the FOMC, and so, again, we have two items for your discussion. I would like to proceed as follows. I am going to turn first to Bill Dudley and his colleagues in New York to give us a brief update on market conditions and then to outline for us the proposed term securities lending facility and how it would work and what we hope it would do in the markets. I don't think extensive exposition of the swaps is necessary, but any questions are welcome. After New York's presentation, we have Bill, Brian Madigan, Scott Alvarez, and other staff here, if you have any questions. Following that, we would have a go-round and get comments and positions, and then we proceed to votes. So without further ado, let me turn to Bill in New York to start with a market update and then to talk a bit about the proposed facility. Bill. " CHRG-111hhrg58044--79 Mr. Price," In the remaining seconds, what factors did Congress rely on when examining and endorsing the non-lending uses of credit information while amending the Fair Credit Reporting Act in 1996 and the FACT Act in 2003? Mr. Snyder? " FOMC20070810confcall--28 26,VICE CHAIRMAN GEITHNER., I don’t agree with that. I don’t think that’s the way to think about it. This is a general signal that we’re prepared to relax or to provide liquidity to help make sure markets come back in some more orderly functioning. You can’t condition that statement without undermining its basic power in some sense. FinancialCrisisReport--316 The Act stated that these reforms were needed, “[b]ecause of the systemic importance of credit ratings and the reliance placed on credit ratings by individual and institutional investors and financial regulators,” and because “credit rating agencies are central to capital formation, investor confidence, and the efficient performance of the United States economy.” 1236 (3) Recommendations To further strengthen the accuracy of credit ratings and reduce systemic risk, this Report makes the following recommendations. 1. Rank Credit Rating Agencies by Accuracy. The SEC should use its regulatory authority to rank the Nationally Recognized Statistical Rating Organizations in terms of performance, in particular the accuracy of their ratings. 2. Help Investors Hold CRAs Accountable. The SEC should use its regulatory authority to facilitate the ability of investors to hold credit rating agencies accountable in civil lawsuits for inflated credit ratings, when a credit rating agency knowingly or recklessly fails to conduct a reasonable investigation of the rated security. 3. Strengthen CRA Operations. The SEC should use its inspection, examination, and regulatory authority to ensure credit rating agencies institute internal controls, credit rating methodologies, and employee conflict of interest safeguards that advance rating accuracy. 4. Ensure CRAs Recognize Risk. The SEC should use its inspection, examination, and regulatory authority to ensure credit rating agencies assign higher risk to financial instruments whose performance cannot be reliably predicted due to their novelty or complexity, or that rely on assets from parties with a record for issuing poor quality assets. 1235 See id. at §§ 931-939H; “Conference report to accompany H.R. 4173,” Cong. Report No. 111-517 (June 29, 2010). 1236 See Section 931 of the Dodd-Frank Act. 5. Strengthen Disclosure. The SEC should exercise its authority under the new Section 78o-7(s) of Title 15 to ensure that the credit rating agencies complete the required new ratings forms by the end of the year and that the new forms provide comprehensible, consistent, and useful ratings information to investors, including by testing the proposed forms with actual investors. 6. Reduce Ratings Reliance. Federal regulators should reduce the federal government’s reliance on privately issued credit ratings. CHRG-111shrg51303--9 Mr. Kohn," Thank you, Mr. Chairman. Chairman Dodd, Ranking Member Shelby, other Members of the Committee, I appreciate having this opportunity to discuss the role of the Federal Reserve in American International Group. My written testimony provides full detail about the support the Federal Reserve, working alongside the Treasury, has given AIG and the reasons for each of our actions. In my oral statement this morning, I would like to touch on the broader themes and provide the context that underlay the actions. Over the past year-and-a-half, this Committee, the Congress, the Treasury, and financial regulators have all been dealing with the ongoing disruptions and pressures engendered by an extraordinary financial crisis. The weaknesses at financial institutions, resulting constraints on credit, declines in asset prices, and erosion of household and business confidence have in turn led to a sharp weakening in the U.S. economy. In addition to the extraordinary assistance provided by the Congress in approving the Emergency Economic Stabilization Act last fall and implemented by the Treasury, the Federal Reserve has employed all the tools at our disposal to break this spiral and help address the many challenges of the crisis and its effects on the economy. One of the most important tools of the Federal Reserve is our authority under section 13(3) of the Federal Reserve Act to lend on a secured basis under ``unusual and exigent'' circumstances to companies that are not depository institutions. And since last fall, in order to foster the stability of the financial system and mitigate the effects of ongoing financial stresses on the economy, we have used that authority to help to stabilize the financial condition of AIG. My full written statement provides a detailed chronology of our actions. I want to put these actions and the reasons for them in context. AIG is the largest insurance company in the United States, controlling both the largest life and health insurer and the second largest property and casualty insurer. It is also one of the largest insurance companies in the world, conducting insurance and finance operations in more than 130 countries, with more than 74 million customers and 116,000 employees globally, including 30 million customers and 50,000 employees in the U.S. As of September 30, 2008, it reported consolidated total assets of slightly more than $1 trillion; it is also the major provider of guaranteed investment contracts and products that protect participants in 401(k) retirement plans. In addition, AIG is the leading commercial insurer in the U.S., insuring operations on more than 180,000 entities. Thus, millions of individual small businesses, municipalities, and corporate customers in the United States rely on AIG for insurance protection on their lives, homes, vehicles, business operations, pensions, investments, and other insurance risks. But AIG is more than just a large insurance company. AIG has been a major participant in many derivatives markets through its Financial Products business unit. Unlike its regulated insurance company affiliates, Financial Products and its activities are not regulated. Financial Products is the counterparty on over-the-counter derivatives to a broad range of hundreds of customers, including many major national and international financial institutions, U.S. pension plans, stable value funds, and municipalities. Financial Products also provided credit protection through credit default swaps it has written on billions of dollars of multi-sector collateralized debt obligations. While Financial Products has been winding down and exiting many of its trades, it continues to have a very large notional amount of derivatives contracts outstanding with numerous counterparties. And it is against this background that the Federal Reserve and the Treasury Department have taken a series of unusual actions to stabilize the company and prevent its disorderly collapse from infecting the broader financial system. These actions have entailed very difficult and uncomfortable decisions for a central bank, as well as the Treasury, because they involved addressing systemic problems created largely by poor decisionmaking by the company itself. Moreover, many of these decisions involved an unregulated business entity that exploited the strength, and threatened the viability, of affiliates that were large, regulated entities in good standing. However, we believe we had no choice if we are to pursue our responsibility for protecting financial stability. Our judgment has been and continues to be that, in this time of severe market and economic stress, the failure of AIG would impose unnecessary and burdensome losses on many individuals, households, and businesses, disrupt financial markets, and greatly increase fear and uncertainty about the viability of our financial institutions. Thus, such a failure would deepen and extend market disruptions and asset price declines, further constrict the flow of credit to households and businesses in the United States and in many of our trading partners, and materially worsen the recession our economy is enduring. To mitigate these risks, the Treasury felt compelled to provide equity capital to AIG and the Federal Reserve to provide liquidity support backed by the assets of AIG. We have restructured our assistance in response to changing economic conditions and, as needed, to mitigate potential risks. These restructurings reflect our continued belief that the disorderly failure of AIG during this period of severe economic stress would harm numerous consumers, municipalities, small businesses, and others who depend on AIG protection, and it would deepen the current economic recession. Taking these actions, we are also committed to protecting the interests of the U.S. Government and the taxpayer. Thank you very much. I would be pleased to take your questions. " FOMC20080130meeting--182 180,MR. STERN.," Thank you, Mr. Chairman. Let me talk about the economic outlook. My initial comments are organized kind of along the lines of Dave Reifschneider's exhibit 1. There are certainly still some positive things going on: growth in exports, and I think that is likely to continue; strength in the agricultural sector and in natural resources in general, outside of lumber and wood products; state and local construction spending--there seem to be a lot of schools, hospitals, sports stadiums, et cetera, being built now; and the labor market may be a bit better than the December household and payroll surveys depicted, given the low level of initial claims. But I think those considerations are really overwhelmed by several factors on the negative side, and let me summarize those quickly. First is the breadth of the negative news on the national economy that we have received recently. The vast bulk of the news has been negative. It doesn't suggest to me that there is a lot of positive momentum or latent strength left in the economy. The second factor I would cite--and this is not new--is the persistence of a large volume of unsold, unoccupied houses, with implications for activity in that sector, for prices, for wealth, and for foreclosures. Of course, as somebody already noted, many recessions turn out to be inventory recessions. If we have one, this will be an inventory recession, too; and the inventory in question is housing. Third, maybe even more important, are the financial conditions themselves--prominently but not exclusively, the impaired capital positions of large banks and likely prospects for growing credit quality problems in auto loans, in credit cards, in commercial real estate, and perhaps in other areas as well. Adding up those considerations, I think what we confront resembles the aftermath of the 1990-91 recession, when so-called headwinds restrained growth in real GDP, and my forecast anticipates something similar going forward, something like the persistent weakness scenario in the latest Greenbook. So I expect subpar growth both this year and next year before better growth resumes in 2010. I further expect lots of inertia in both core and overall measures of inflation this year and next before some diminution below 2 percent in 2010. Thank you. " CHRG-111shrg50815--67 Mr. Plunkett," That is correct, Senator, and the obvious point here is if there is a record on a credit report, for example, somebody is more than 30 days late or there is another issue with their credit report that would allow the issuer to use universal default to reprice them, they are not going to switch in this climate. They are not going to be able to switch. It is going to be much harder. Issuers are being much more cautious and their ability to change cards will be very limited. Senator Reed. Thank you very much. Thank you, Mr. Chairman. I apologize for going over. " CHRG-111shrg50814--99 Mr. Bernanke," Senator, that is a very important question, the exit strategy. We have been spending a lot of time working on that. In order to be able to start raising interest rates again and going back to more normal monetary policy, we are going to have to bring down the size of our balance sheet. Fortunately, a very large part of our balance sheet, well over half of our lending, is in very short-term types of loans, 3 months or even in some cases just a few days, so as the need for that credit weakens, is reduced by the strengthening economy, those programs will naturally tend to contract and the balance sheet will naturally tend to decline. So a lot of it will just happen as the economy strengthens, as the need for that credit dissipates, and in particular, since for many of the program we have created, the terms are somewhat more punitive than would be normal under normal circumstances, as the markets begin to normalize, then borrowers will tend to move away from the Fed facilities and into the private sector facilities. So we think that those markets, those programs will tend to contract on their own to some extent and we can always, of course, contract them ourselves as we determine that we need to reduce the size of the balance sheet. We have a number of other tools, and I don't want to take all your time, Senator, but just to give one example. In the EESA bill last October, the Congress gave the Fed the ability to pay interest on excess reserves, and our ability to do that will help us raise interest rates at the time it is needed even if the balance sheet is not all the way back down to where it was when we started this process. So we are very, very focused on making sure that we are able to normalize monetary conditions at the appropriate time. At the same time, we also don't want to give up opportunities where we think we can help the markets function better and provide some support for this economy. Senator Martinez. Thank you very much, Mr. Chairman. Senator Reed. Senator Kohl. Senator Kohl. Thank you very much. Chairman Bernanke, I am sure you have given this some thought and perhaps discussed it with many people down at the Federal Reserve. How much money do you think we will have to invest in our banks in order to make them stable and to resume their normal functions? " CHRG-110hhrg44901--51 Mr. Bernanke," Congresswoman, as I indicated in my testimony, we at this point are balancing various risks to the economy. And as we go forward, my colleagues and I are going to have to, you know, see how the data come in and how the outlook is changing and try to find the policy that best balances those risks and best achieves our mandate of sustainable growth and price stability. So I don't know how to answer beyond that, other than to say that we are going to be responsive to conditions as they evolve. I noted today the importance of not letting inflation from commodities enter into a broader and more persistent and more pernicious inflation. That is certainly an important priority. But in general, we are going to have to just keep evaluating the new information and see how it affects the outlook. Monetary policy works with a lag. We can't look out the window and do something that will affect the economy today. So the best we can do is try to make forecasts and try to adjust our policy in a way that brings the forecast towards the desired outcome. Ms. Velazquez. Well, Mr. Chairman, I understand all the steps and actions taken by the Fed. But it seems to me that the lending tools are proving to be ineffective at this point. Doesn't this prove that the current economic conditions have moved beyond a liquidity crisis that can be mitigated through Federal lending and is now proven to be a capital crunch? " CHRG-111shrg51290--69 Source: FDIC Statistics on Depository Institutions The second-worst performance record among depository institution lenders went to national banks. State thrifts had better default rates than either type of federally chartered institution in 2007 and 2008. State banks consistently had the lowest default rates of all. Among these charter types, the only ones that enjoy Federal preemption are national banks regulated by the OCC and Federal thrift institutions regulated by the OTS. State banks and State thrift institutions do not. Thus it appears, at least among depository institutions, that Federal preemption was associated with higher default rates, not lower rates, during 2006 through 2008, when credit standards hit bottom and the mortgage market imploded. These data do not address whether that independent nonbank lenders have even higher default rates in some states and that may in fact be the case. Nevertheless, the data undercut the assertion that Federal preemption reduces default rates among mortgages by depository institution lenders. To the contrary, the lowest default rates were at State banks and thrifts, which are subject both to State and Federal regulation.IV. What to Do Dual regulation and the resulting crazy quilt of laws encouraged lenders to shop for the lightest rules. In turn, this pressured regulators to weaken their standards and to relax enforcement of safety and soundness and consumer protection laws. Casting underwriting standards to the wind in a seemingly obscure corner of the consumer credit market ended up triggering a global recession. This crisis shows that the United States ignores consumer protection at its peril. If it was not clear before, we now know that systemic stability and consumer protection are inextricably linked. To correct the regulatory lapses that I have described, our financial regulatory system needs to adopt three reforms: First, Congress should adopt uniform minimum safety standards for all providers of consumer credit, regardless of the type of entity or charter. Second, the authority for administering and enforcing these standards should be housed in one Federal agency whose sole mission is consumer protection. Third, to avoid the risk of agency inaction, Congress should give parallel enforcement authority to the states and allow consumers to bring private causes of action to recover for injuries they sustain.I expand on these proposals below.A. Uniform Federal Safety Standards For Consumer Credit The downward spiral in underwriting standards drove home the need for minimum, uniform consumer credit safety standards. Adopting a uniform Federal floor would prevent lenders and brokers from seeking safe havens in legal regimes that do little or nothing to protect consumers. The purpose of these uniform Federal standards is three-fold. First, the standards should ensure proper loan underwriting based on the consumer's ability to repay. Second, the standards should prohibit unfair or deceptive practices in consumer credit products and transactions. Finally, the standards should promote transparency through improved consumer disclosures, product simplification and product standardization. Bottom-line, Federal standards should make it possible for consumers to engage in meaningful comparison shopping, with no hidden surprises. The experience with the high-cost loan provisions of HOEPA reveals that a detailed regulatory statute limited to specific loan terms is not an effective approach. HOEPA has proven too rigid and has failed to address new abuses as they appeared in the mortgage market. Instead, Congress should authorize a broad statutory mandate to give the implementing agency the flexibility to respond promptly to industry innovations (both good and bad) in the consumer credit industry. This broad statutory model would be akin to the open-ended provisions found in Section 5 of the Federal Trade Commission Act and Section 10(b) of the Securities Exchange Act of 1934, instead of the highly detailed prohibitions found in HOEPA. Congress should then delegate broad authority to the implementing agency to promulgate rules--preferably objective ones--to implement the statute. The uniform standards should constitute a floor, in which weaker State laws are federally preempted. Under the statute, however, states should remain free to enact stricter consumer protections so long as those protections are consistent with the Federal statute. A minimum Federal floor, instead of a ceiling, is critical for three reasons. First, states are closer to local conditions and often more responsive to emerging problems at home. A Federal floor would preserve the states' ability to protect their citizens. Second, giving latitude to states to adopt stricter standards would preserve the states' important role as laboratories of experimentation. Finally, a Federal floor, not a ceiling, would provide an important safeguard against the possibility that the implementing agency might adopt weak rules or fail to update the rules. As part of or in addition to creating the uniform Federal standards just outlined, Congress should transfer the authority to administer other existing Federal consumer credit laws to the implementing agency. At a minimum, oversight for the Truth in Lending Act, HOEPA, the Real Estate Settlement and Procedures Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the fair lending laws, the Fair Credit Billing Act, and the Home Mortgage Disclosure Act should be transferred to this agency.\58\ Responsibility for administering Section 5 of the Federal Trade Commission Act as it applies to all providers of consumer credit should also be consolidated in this agency.--------------------------------------------------------------------------- \58\ This agency should also receive sole responsibility for administering the Consumer Leasing Act, the Right to Financial Privacy Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Women's Business Ownership Act, the Fair Credit and Charge Card Disclosure Act, the Home Equity Loan Consumer Protection Act, the Truth in Savings Act, title V of the Gramm-Leach-Bliley Act, and the Fair and Accurate Credit Transaction Act.---------------------------------------------------------------------------B. A Dedicated Federal Agency Whose Sole Mission is Consumer Protection1. Federal Regulators Cannot Serve Two Masters The housing bubble and hazardous mortgages by federally regulated depository institutions show that we cannot expect consumer protection to be paramount to Federal banking regulators. Recent history has shown that the safety and soundness mandate of Federal banking regulators regularly eclipses concern for consumer protection. For this reason, the consumer protection function should be removed from Federal banking regulators and housed in its own agency whose sole mission is consumer protection. The bank regulatory agencies' own mission statements make it clear that consumer protection is a low priority. For example, the Federal Reserve Board divides its duties into four general areas:\59\--------------------------------------------------------------------------- \59\ The Federal Reserve System, Purposes & Functions 1 (9th ed. 2005). ``conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term --------------------------------------------------------------------------- interest rates ``supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers ``maintaining the stability of the financial system and containing systemic risk that may arise in financial markets ``providing financial services to depository institutions, the U.S. Government, and foreign official institutions, including playing a major role in operating the nation's payments system.''In the Fed's description, monetary policy comes first, followed by banking supervision. Consumer protection does not even merit its own bullet point. Similarly, safety and soundness regulation is the paramount mission of the OCC and OTS. The OCC describes its mission as having four objectives, the last of which is consumer protection:\60\--------------------------------------------------------------------------- \60\ Comptroller of the Currency, About the OCC (viewed February 28, 2009), available at http://www.occ.treas.gov/aboutocc.htm. ``To ensure the safety and soundness of the national --------------------------------------------------------------------------- banking system. ``To foster competition by allowing banks to offer new products and services. ``To improve the efficiency and effectiveness of OCC supervision, including reducing regulatory burden. ``To ensure fair and equal access to financial services for all Americans.''Like the OCC, OTS describes safety and soundness as its principal job:\61\--------------------------------------------------------------------------- \61\ Office of Thrift Supervision, Mission and Goals (viewed February 28, 2009), available at http://www.ots.treas.gov/?p=MissionGoal. To supervise savings associations and their holding companies in order to maintain their safety and soundness and compliance with consumer laws, and to encourage a competitive industry --------------------------------------------------------------------------- that meets America's financial services needs. In theory, safety and soundness should serve consumer protection. In practice, it has not, as recent experience shows. During the housing boom, Federal banking regulators too often mistook short-term profitability, including profits from excessive fees on consumers,\62\ with safety and soundness. In their effort to protect the short-term profitability of banks and thrifts, Federal regulators often dismissed consumer protection as conflicting with that mission. When agencies derive most of their operating budgets from assessments on the entities they regulate--as do the OCC and OTS--the pressure to sacrifice consumer protection for profit maximization by those entities can be overwhelming.\63\--------------------------------------------------------------------------- \62\ Examples include regulators' slow response to curtailing large prepayment penalties and their continued indecision on costly overdraft protection. \63\ For instance, the OCC derives 95 percent of its budget from assessments on national banks. The twenty largest national banks contribute almost 60 percent of those assessments. See, e.g., Bar-Gill & Warren, supra note 5, at 193-94 (working draft version); Testimony of Arthur E. Wilmarth, Jr., Hearing before the Subcomm. on Financial Institutions and Consumer Credit of the House Comm. on Financial Services (Apr. 26, 2007).--------------------------------------------------------------------------- I served on the Federal Reserve Board's Consumer Advisory Council from 2002 through 2004 and saw firsthand how resistant Federal banking regulators were to instituting basic consumer protections during the run-up to the current crisis. Repeatedly over that period, I and other members of that Council warned the Federal Reserve's staff and Governors about rising foreclosures and other dangers associated with reckless subprime loans. We urged the Board to exercise its powers under HOEPA to strengthen protections for subprime and nontraditional mortgages, but to no avail. During my tenure on the Council, the late Governor Gramlich told me during a break at one of the Council's public meetings that there was not enough support on the Board to expand HOEPA's protections. These experiences confirmed my belief that banking regulators often dismiss the consumer protection piece of their mission. Some critics argue that removing consumer protection responsibilities from Federal banking regulators and housing them in their own dedicated agency would undercut the safety and soundness of banks. As the current crisis shows, however, entrusting consumer protection to the Federal banking agencies is no guarantee of bank safety and soundness. Indeed, having a separate Federal watchdog for consumer credit would help place healthy, countercyclical constraints on the tendency of Federal banking regulators to sacrifice long-term safety for short-term profits at the top of the credit cycle. It would also encourage forward-looking regulation as new problems arise, instead of laggard, backward-looking regulation of the type recently issued by the Federal Reserve. Congress could institute mechanisms to avoid agency conflicts or to resolve them if they occur. Such mechanisms could include formal or informal consultation with Federal banking regulators or judicial dispute resolution.2. A Separate Federal Consumer Credit Agency Offers Other Strong Advantages A wide range of experts across the political spectrum, from the Treasury Department under former Secretary Paulson to the Congressional Oversight Panel, have recommended housing consumer credit protection in its own separate agency.\64\ A separate Federal agency dedicated to consumer protection for all consumer credit would offer several distinct advantages. First, it would consolidate industry-wide enforcement in one agency, which would mean that all providers of credit would be subject to the same level of enforcement. Under the current regime, even though the Federal Reserve Board administers most Federal consumer credit laws, compliance examinations and enforcement are divided among Federal banking regulators and sometimes other agencies. Other Federal consumer protection laws--such as Section 5 of the Federal Trade Commission Act and the Community Reinvestment Act--are individually implemented by the four Federal banking regulators with respect to their regulated entities. Each agency can make its own choice about the extent to which it enforces or does not enforce the law. Ending this fragmentation of enforcement would discourage lenders from switching charters in search of the easiest regulator.--------------------------------------------------------------------------- \64\ The Department of the Treasury, Blueprint for a Modernized Financial Regulatory Structure 170-74 (March 2008) (proposing a Conduct of Business Regulatory Agency), available at www.treasury.gov; Congressional Oversight Panel, Special Report on Regulatory Reform 30-37 (Jan. 2009), available at http://cop.senate.gov/documents/cop-012909-report-regulatoryreform.pdf. The Committee on Capital Markets Regulation recommended an independent consumer protection agency as one alternative. Committee on Capital Markets Regulation, Recommendations for Reorganizing the U.S. Financial Regulatory Structure 5 (Jan. 14, 2009), available at http://www.capmktsreg.org. While the Government Accountability Office has not taken a position, last month it advised that ``[c]onsumer protection should be viewed from the perspective of the consumer rather than through the various and sometimes divergent perspectives of the multitude of Federal regulators that currently have responsibilities in this area.'' General Accountability Office, Financial Regulation: a Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System 18 (GAO-09-349T Feb. 4, 2009), available at www.gao.gov. See also Heidi Mandanis Schooner, Consuming Debt: Structuring the Federal Response to Abuses in Consumer Credit, 18 Loyola Consumer L. Rev. 43, 77-78, 82 (2005) (``while there are benefits to combining prudential regulation and consumer protection, serious doubt remains as to whether it is the best arrangement''; ``[t]he most sensible approach to correcting the structural defect in the current regime would be to eliminate entirely the Federal banking regulators' role in consumer protection'').--------------------------------------------------------------------------- Transferring consumer credit laws to one agency whose sole mission is consumer protection would also provide regulators with a complete overview of the entire consumer credit market, its structure, and emerging issues. Right now, consumer credit regulation suffers from a silo mentality because it is parceled out among so many agencies. Consolidating consumer credit oversight would overcome this silo mentality. In addition, consolidation would have the benefit of concentrating expertise for consumer credit products in one agency.3. Agency Responsibilities and Oversight In assigning consumer credit protection to its own separate agency, it is necessary to ask whether the agency should adopt a supervisory model based on routine examinations akin to banking regulation or an enforcement model akin to that used by the Security and Exchange Commission or the Federal Trade Commission. Banking regulators are supposed to examine all of their regulated entities for consumer compliance on a routine basis. Requiring regular examinations of all credit providers and related entities, from depository institutions and nonbank lenders to mortgage brokers and payday lenders, would be extremely costly and not the best use of tax dollars. Given the large number of participants in the consumer credit market, it would make more sense to adopt an enforcement model similar to that used by the Securities and Exchange Commission.\65\ Under that model, market participants would be required to register with the agency and obtain licenses. Regular reporting would provide the agency with a steady flow of needed information to pinpoint possible violations and identify new problems. Under its broad statutory mandate, the agency would issue binding rules and interpretations to prohibit unfair and deceptive acts and practices. The agency's research arm would conduct empirical tests of the effects of new financial products and proposed regulations. Finally, the agency should have strong enforcement authority, including the power to conduct special examinations and issue subpoenas; the power to take agency enforcement action and levy restitution and sanctions; and criminal and civil enforcement authority.--------------------------------------------------------------------------- \65\ A consumer complaint model alone, such as that employed by the FTC, would not provide an oversight agency with enough information or authority to keep abreast of the rapid pace of financial innovation.---------------------------------------------------------------------------4. Should Congress Create a New Agency or Transfer All Consumer Credit Oversight to the Federal Trade Commission? In removing consumer credit oversight from Federal banking regulators and transferring it to a dedicated agency, Congress must decide where to house it. There are two obvious choices. One would be to create a new agency for consumer credit oversight. The other would be to transfer this responsibility to the Federal Trade Commission. Each approach has advantages and disadvantages. Unlike the FTC, a brand new agency would be solely responsible for consumer credit products and would not be distracted by other duties, such as policing antitrust violations or the marketing of home appliances, over-the-counter drugs, dietary supplements, computer software, and other products, that fall under the FTC's purview. A new agency would also have the benefit of starting on a clean slate. If, as I recommend, the model for consumer protection is based on the SEC's registration and reporting scheme, the FTC would have to transform itself away from its current consumer complaint enforcement model. The FTC, like any other agency, has a bias toward the status quo that could make it hard to implement a new enforcement model and otherwise change the way the agency functions. A new agency would not suffer under this handicap. On the other hand, creating a new Federal agency would be costly and entail substantial startup time. The FTC already has the institutional expertise and single-minded commitment to consumer protection to regulate consumer credit industry-wide. This is particularly true within the FTC's Division of Financial Practices and the Division of Privacy and Identity Protection, which fall in the FTC's Bureau of Consumer Protection. In 2008, the Division of Financial Practices specifically ramped up its staff and in-house training in anticipation of heightened enforcement activity. Of course, for the FTC to succeed as the consumer protection enforcer, the agency would need dramatic increases in funding. A new agency would also need a substantial commitment of resources to properly do its job. Presumably, some of this cost could be defrayed by transferring resources from the consumer compliance operations of Federal banking regulators. Consolidating oversight in one Federal agency--whether that agency is new or the FTC--poses a final concern about agency capture and inaction. The FTC, for example, had a vigorous enforcement record regarding mortgage abuses during the Clinton Administration but a lackluster record during the George W. Bush Administration until recently. Whether consumer credit protection is consolidated in a new agency or the FTC, the best antidote to agency inaction is outside enforcement. Accordingly, Congress should give parallel enforcement authority for Federal consumer credit laws to State regulators and private causes of action (including carefully crafted assignee liability) to injured consumers. Congress could also set target consumer protection goals, such as maximum default rates, and require the implementing agency to report to Congress on its performance. Finally, that agency should be funded through congressional appropriations instead of assessments on regulated entities to assure that the agency remains independent. CHRG-110shrg50416--171 RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM ELIZABETH A. DUKEAIGQ.1. Former AIG CEO Hank Greenberg recently wrote a letter that was reported in the Washington Post as saying, ``Unless there is immediate change to the structure of the Federal loan [to AIG], the American taxpayer will likely suffer a significant financial loss.'' (Washington Post, November 3, 2008). However, in the Federal Reserve Board's report to the Senate Banking Committee about the Fed's actions with respect to AIG under Section 13(3) of the Federal Reserve Act, the Board told the Committee that it does not expect the loans to result in any losses to the Federal Reserve System or the taxpayer. Can you please explain why Mr. Greenberg is incorrect?A.1. Outstanding advances to AIG under the credit facility initially provided to AIG on September 16, 2008 (the Revolving Credit Facility) are secured by the pledge of assets of AIG and its primary non-regulated subsidiaries, including AIG's ownership interest in its regulated U.S. and foreign subsidiaries. AIG has announced a comprehensive and global divestiture program to raise funds to repay the Revolving Credit Facility. These dispositions will include subsidiaries that rank among the largest and most prominent businesses in the industry. As part of our oversight activities arising from our role as a lender to AIG, Federal Reserve staff, assisted by expert advisers that we have retained, reviews this divestiture program and closely monitors the company's progress in implementing the divestiture program's objectives on an ongoing basis, as well as cash flows and financial condition. The Federal Government's restructuring of its financial relationship with AIG announced on November 10, 2008, which includes the acquisition of $40 billion in newly issued Senior Preferred Stock of AIG by the U.S. Treasury, and the modification of some of the initial terms of the Revolving Credit Facility, should enhance AIG's ability to repay the Facility by, among other things, providing additional time to execute its asset disposition plan. Given the substantial assets of AIG and the senior and secured position of the Revolving Credit Facility, the Board expects that the Revolving Credit Facility will not result in any net loss to the Federal Reserve or taxpayers. Advances to Maiden Lane II LLC (ML II) and to Maiden Lane III LLC (ML III) under the credit facilities established to partially fund the acquisition of certain AIG-related assets by these special purpose vehicles are secured by a lien on all of the assets held by ML II and ML III respectively. Given the expected amounts to be realized from the cash flows produced by these assets as well as the proceeds from disposition of these assets over time, and the subordinated positions of AIG in ML II and ML III, the Board does not expect any net cost to the taxpayers as a result of the failure to repay the credit extended by the Federal Reserve to ML II and ML III.Q.2. What is the total sum of money the Federal Reserve System has lent to AIG through any and all actions undertaken by the Federal Reserve, including the Commercial Paper Funding Facility (CPFF)? What process was used to determine AIG's eligibility to participate in the CPFF? Did the Federal Reserve consider the fact that AIG was already subject to special Fed lending when deciding AIG's eligibility to participate in the CPFF?A.2. As initially structured in September 2008, the Revolving Credit Facility allowed AIG to borrow up to $85 billion. From inception of this Facility to November 5, 2008, the total aggregate amount of borrowings were approximately $77.0 billion, of which approximately $16.0 billion was repaid on or before that date. In connection with the U.S. Treasury's announcement that it would acquire $40 billion in AIG Senior Preferred Stock in November, the proceeds of which were used to repay amounts outstanding under the Facility, the total amount of credit permitted to be outstanding under the Facility was reduced to $60 billion. As of December 31, 2008, AIG had approximately $38.9 billion in advances outstanding under the Facility. Four AIG affiliates, AIG Funding, Inc., International Lease Finance Corporation, Curzon Funding LLC, and Nightingale Finance LLC, have borrowed from the CPFF. Under the terms of the CPFF, these four affiliates may borrow an aggregate amount of up to approximately $20.9 billion from that Facility. As of November 5, 2008, these four affiliates had borrowed an aggregate amount of approximately $15.2 billion under the CPFF. By its terms, the CPFF is available to any U.S. issuer of commercial paper that meets the eligibility requirements of the Facility. Among other requirements, the commercial paper financed through the CPFF special purpose vehicle must be rated A-1/P-1/F-1 by a major nationally recognized statistical rating organization. The fact that a particular issuer may be eligible to borrow under; or be affiliated with an eligible borrower under, other credit facilities established under section 13(3) of the Federal Reserve Act does not disqualify the issuer under the terms of the CPFF. For example, affiliates of primary dealers that have access to the Primary Dealer Credit Facility are not ineligible to borrow under the CPFF. The four AIG affiliates that are borrowers from the CPFF meet the eligibility criteria of that Facility. The Federal Reserve Bank of New York (FRBNY) is authorized to provide up to $22.5 billion in senior secured credit to ML II to partially fund its acquisition of approximately $40 billion (par value) in residential mortgage-backed securities from AIG. As of December 31, 2008, the FRBNY had lent $19.5 billion to ML II. As a result of the ML II credit facility, on December 12, 2008, the Securities Borrowing Facility for AIG, through which the FRBNY could lend up to $37.8 billion in cash to AIG in exchange for collateral in the form of investment grade securities that were being returned by AIG's securities lending counterparties, was terminated. On November 5, 2008, before the Securities Borrowing Facility was terminated, AIG had borrowed approximately $19.9 billion under that Facility. All borrowings under the Securities Borrowing Facility were repaid in full when the facility was terminated on December 12, 2008. The FRBNY is authorized to provide up to $30 billion in senior secured credit to ML III to partially fund its acquisition of approximately $69 billion (par value) of multi-sector collateralized debt obligations (CDOs) protected by credit default swaps (CDS) and similar contracts written by AIG. As of December 31, 2008, FRBNY had lent $24.3 billion to ML III.Q.3. What is AIG's market capitalization? Is the present value of AIG's equity and assets (using mark-to-market accounting) greater than AIG's liability to the Federal Reserve?A.3. As explained in response to Question 1, advances under the Revolving Credit Facility are to be repaid with the proceeds of asset sales by AIG, including the disposition of many of its major U.S. and foreign insurance subsidiaries. The shares of the insurance subsidiaries of AIG are not themselves publicly traded or valued on a mark-to-market basis. Based on its recent common stock price, as of year-end 2008, AIG's market capitalization was approximately $4.2 billion. However, current market capitalization is not necessarily a reliable indicator of the value that the purchasers of AIG's businesses, which rank among some of the most prominent in the industry, will pay for these assets and thus the amount of proceeds that will be received from the disposition of these businesses. As stated above, in light of the substantial assets of AIG and the senior and secured position of the Revolving Credit Facility, the Board expects that the Revolving Credit Facility will not result in any net loss to the Federal Reserve or taxpayers.Q.4. How has AIG used the funding the System has provided, and what analysis have you done to conclude that the loans will be repaid?A.4. Consistent with the terms of the Revolving Credit Facility, AIG has used the proceeds of advances under the Revolving Credit Facility for general corporate purposes, including as a source of liquidity to pay obligations as and when they become due. Since the establishment of the Facility, a significant portion of the Facility proceeds has been used to meet continued cash requirements associated with AIG's securities lending program and for collateral calls related to its portfolio of CDS and similar contracts AIG had written on multi-sector CDOs. In the future, draws on the Revolving Credit Facility are not expected to be used for these purposes to a significant extent because the credit facilities provided to ML II and ML III are designed to address the liquidity pressures on AIG related to these factors. Draws on the Facility going forward may continue to be used for other general corporate purposes, such as to repay maturing debt obligations and provide operating funds, loans or capital to the company's subsidiaries. See the answer to Question 1 for a description of the steps Federal Reserve staff is taking with regard to assessing whether outstanding advances under the Revolving Credit Facility will be repaid.Q.5. Has the Federal Reserve put any restrictions on the lobbying activities of AIG? Have any other restrictions been placed on AIG's business or other activities?A.5. As is usual in commercial lending transactions involving distressed borrowers, the Federal Reserve has certain rights as a creditor under the loan documentation relating to the Revolving Credit Facility, such as the right to require that overall corporate governance be acceptable to the Federal Reserve. Other provisions in the loan documentation include a prohibition, while the Federal Reserve Facility is outstanding, on making certain types of shareholder distributions, such as payment of dividends on common stock, and a requirement to submit to the Federal Reserve as lender a significant number of financial statements and reports that address a broad range of topics relating to the financial condition and future prospects of AIG. Regarding restrictions on its business, AIG may not make material changes to its business activities without the consent of the Federal Reserve, and may not enter into new swap transactions except under policies approved by the Federal Reserve or to hedge or mitigate risks. Although the Federal Reserve loan documentation does not specifically address AIG's lobbying activities, as a condition of the Treasury's acquisition of $40 billion in Senior Preferred Stock under the Troubled Assets Relief Program (TARP), AIG must maintain and implement a written policy on lobbying, governmental ethics, and political activities that, among other things, applies to AIG and all of its subsidiaries and affiliated foundations. This policy may not be materially amended without the prior written consent of the Treasury.Q.6. While financial problems in AIG Financial Products have been detailed by the Federal Reserve and the press, specifically regarding credit default swaps, Board staff has indicated that the life insurance company held by AIG may also have financial problems. Please detail these financial problems. Please indicate whether any of the loans, and if so, what amount, has been spent in the life insurance, and other insurance companies.A.6. During the first three quarters of 2008, AIG reported significant losses arising primarily from other-than-temporary-impairment charges on its investment portfolio, which was the result to a significant extent of declines in the market values of mortgage-backed securities AIG held in connection with the securities lending program operated by AIG's regulated insurance subsidiaries. To address the losses from this activity during the period from inception of the Federal Reserve's Revolving Credit Facility to November 5, 2008, AIG had used about $19 billion of advances from the Facility to make capital contributions to its insurance companies or to repay obligations to the securities lending program. The ML II credit facility was designed to help AIG address these positions. ML II acquired from AIG's insurance subsidiaries, in return for cash, the residential mortgage-backed securities that these subsidiaries held as part of the securities lending program. These actions allow ML II to manage and realize the underlying value of these securities over the longer term, and relieve AIG and its insurance subsidiaries from the short-term volatility in the mark-to-market value of these assets in the current economic environment. These actions also were designed to enhance the safety and soundness and overall financial condition of the insurance companies.Q.7. In return for the Federal Reserve loan, the federal government now controls almost 80 percent of AIG. What federal entity is/will control this large share of AIG? What decisions have been made about how this control will be exercised? How many Federal Reserve or other federal staff are currently on-site at AIG? Please detail the roles of these staff.A.7. Under the terms of the Revolving Credit Facility as amended, AIG will issue shares of perpetual, non-redeemable convertible preferred stock to a trust that will hold the stock for the benefit of the U.S. Treasury. The preferred stock is convertible into 77.9 percent of AIG's outstanding common stock. Decisions regarding the exercise of any voting rights associated with this preferred stock and regarding any disposition of the stock to third parties will be made by the independent trustees of the trust. In addition to this equity interest, the Treasury Department, in connection with its acquisition of $40 billion of senior preferred stock of AIG under the TARP, also received warrants to purchase 2 percent of the common stock of AIG. Control over these instruments is exercised by the Treasury Department in compliance with the rules and conditions applicable to the TARP. A team of approximately 10 Federal Reserve staff, led by a Senior Vice President of the FRBNY, has primary responsibility for managing and implementing the oversight of AIG provided for in the loan documentation relating to the Revolving Credit Facility. Federal Reserve staff are on-site at AIG to monitor the company's funding, cash flows, use of proceeds, and progress in pursuing its divestiture plan. Federal Reserve representatives are also in regular contact with AIG senior management and attend all AIG board meetings and board committee meetings.Q.8. Board staff has indicated that the Federal Reserve has not taken a close look at the solvency of the insurance companies held by AIG because those activities are regulated at the state level. Is this correct? Has the Federal Reserve done a thorough analysis of AIG's insurance companies, including their solvency?A.8. Under the existing statutory framework, the relevant state insurance regulatory authorities have the primary responsibility for determining the financial condition of AIG's insurance company subsidiaries. This includes the authority to take action to resolve regulated insurance companies that fail to meet the state regulator's capital, solvency, and other regulatory requirements. As a lender to MG, the Federal Reserve closely monitors the cash flow, earnings, and general financial condition of the company on a consolidated basis, which includes reviewing financial information on all of the company's major subsidiaries, including the insurance subsidiaries. In carrying out this oversight responsibility, the Federal Reserve coordinates on an ongoing basis with the appropriate state insurance authorities.EESAQ.9. What actions has the Board taken to implement a plan under Section 110 of the Emergency Economic and Stabilization Act of 2008 with respect to foreclosure mitigation for mortgages or mortgage-backed securities held, owned, or controlled by or on behalf of a Federal Reserve Bank?A.9. Section 110 of the Emergency Economic Stabilization Act directs Federal property managers, to the extent that they hold, own, or control mortgages, mortgage-backed securities, and other assets secured by residential real estate (residential mortgage assets), to ``implement a plan that seeks to maximize assistance for homeowners and use its authority to encourage the servicers of the underlying mortgages, and considering net present value to the taxpayer, to take advantage of the HOPE for Homeowners Program under section 257 of the National Housing Act or other available programs to minimize foreclosures.'' Section 110 generally provides that the Federal Reserve Board (Board) is a Federal property manager with respect to any mortgage, mortgage-backed securities, or pool of such securities (residential mortgage assets) held, owned, or controlled by or on behalf of a Federal Reserve Bank other than residential mortgage assets that are held, owned, or controlled by or on behalf of a Federal Reserve Bank ``in connection with open market operations under section 14 of the Federal Reserve Act (12 U.S.C. 353), or as collateral for an advance or discount that is not in default.'' The Board is currently not a Federal property manager for any residential mortgage assets within the scope of section 110. To the extent that residential mortgage assets are held, owned or controlled by the Federal Reserve Banks, these assets are held, owned or controlled in connection with open market operations or as collateral for advances or discounts that are not in default, such as the credit extended to Maiden Lane LLC.\1\--------------------------------------------------------------------------- \1\ Maiden Lane LLC is the limited liability company to which a portfolio of assets was transferred in connection with a loan by the Federal Reserve Bank of New York, which facilitated the acquisition of The Bear Stearns Companies Inc. by JPMorgan Chase & Co.--------------------------------------------------------------------------- Nonetheless, the Board is in the final stages of developing a foreclosure mitigation policy for use by the Federal Reserve Banks. In addition to applying this policy in situations required by section 110, the Board will consider whether there are situations in which it is appropriate and feasible for the Board to apply the policy voluntarily. In developing this policy, the Board has consulted with the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and other governmental and industry representatives, and has carefully considered recent developments and changes to industry protocols relating to foreclosure mitigation. The Board expects to finalize and vote on this policy soon and will promptly submit a copy of its policy once approved to Congress. The goal of the policy will be fully consistent with the requirements and goals of section 110 to offer distressed homeowners a sustainable loan modification when such action would result in a higher expected net present value (NPV) than would be expected through foreclosure. Specifically, what goals has the Board established for the number or percentage of mortgages that should be modified to comply with the Act? Any portfolio that becomes subject to the Board's foreclosure mitigation policy will contain unique characteristics, such as the number of whole residential mortgage loans versus residential mortgage-backed securities, the percentage of senior mortgage loans versus subordinate mortgage loans, and the number of performing loans versus non-performing loans. To account for these variables, the Board does not expect to establish a pre-set number or percentage of loans that must be modified under its policy. However, as noted above, the Board's over-arching goal under the policy will be to try to keep consumers in their homes by offering sustainable loan modifications when the expectedNPV of a loan modification would be greater than the expected NPV of the net proceeds to be received through foreclosure. What process has the Board established to communicate the plan, including modification goals, to Maiden Lane or the regional Federal Reserve Bank that would serve as the agent for the Board in carrying out its duty under the law? As noted above, the Board is in the final stages of developing a foreclosure mitigation policy to guide the Federal Reserve Banks in the event that the Board becomes a Federal property manager. The Board will transmit that policy to the Reserve Banks and require that the Reserve Banks, and any agents they may hire to assist in the management or servicing of the mortgage portfolios subject to section 110, abide by the policy. How many Bear Stearns loans have been modified to date and what were the terms? Wells Fargo & Company (Wells Fargo) and EMC Mortgage Corporation currently act as the servicers of the whole residential mortgages that serve as collateral for the loan to Maiden Lane LLC. Both Wells Fargo and EMC Mortgage are members of the HOPE NOW Alliance and utilize industry standard protocols for loan modifications that are consistent with the standards and guidelines established by the HOPE NOW Alliance. Loan modifications for mortgages that serve as collateral for the loan to Maiden Lane LLC have been offered to delinquent borrowers who are facing other-than-temporary economic hardships, but who may have the capacity to perform on the loan following a modification of terms that provides an expected NPV greater than what would be expected through foreclosure. Workout plans, which are not formal loan modifications, are offered to borrowers with temporary problems and need assistance bringing their account current through short-term modifications to their payments. The ability to offer loan modifications and workout plans for loans that serve as collateral for the extension of credit to Maiden Lane LLC is contingent on whether the subject assets are whole mortgage loans rather than mortgage-backed securities. Because mortgage-backed securities are pools of mortgages in which the Federal Reserve Bank only holds a fractional interest along with other investors, the Reserve Bank does not have direct control over the servicing of those residential mortgage assets. The majority of residential mortgage assets that serve as collateral for the loan to Maiden Lane LLC are in the form of residential mortgage-backed securities. Moreover, all of the residential whole loans in the portfolio were performing as of March 14, 2008, when Maiden Lane LLC acquired the portfolio. As of November 30, 2008, slightly more than 11 percent of the residential mortgage whole loans that serve as collateral for the loan to Maiden Lane LLC and that were both nonperforming and more than 60 days past due had been permanently modified through a reduction in interest rate, an extension of term, a deferral or reduction in the principal balance, or a combination of such actions. Typically, permanent loan modifications initially are considered when borrowers become 60 days or more past due. The number of permanent loan modifications is expected to increase in the coming months. A significant portion of the loans currently 60 days or more past due only reached this stage recently and, as you know, the loan modification process, even under the best of circumstances, can take time, as the borrower must be contacted and appropriate analysis conducted to confirm that a modification is both appropriate and sustainable. Moreover, the loan modifications currently offered to borrowers for the loans backing the credit extension to Maiden Lane LLC become permanent only after a borrower makes three timely payments under the modified terms. Therefore, the number of permanently modified loans is expected to increase as more delinquent borrowers are contacted and finish the negotiation process and as borrowers that are in their three-month verification period fulfill their obligations and receive permanent loan modifications. In addition, many delinquent borrowers are receiving flexible terms and assistance that may lead to loan workouts in forms other than formal loan modifications--for example, short sales or in the case of borrowers facing temporary financial hardships, a repayment plan. These workouts are not included in the stated percentage of loan modifications.Q.10. I commend the Administration for following through with Section 112 of EESA by convening an international summit on November 15th. In announcing the summit, the White House explained that leaders of the G20 and key international financial institutions will review progress on measures taken to address the financial crisis and to discuss principles for reform of regulatory and institutional regimes going forward. Please describe what the Federal Reserve and Treasury Department intend to accomplish through this summit and the subsequent working group meetings that will follow the summit--specifically, what types of principles for regulatory and institutional modernization will the United States pursue in the international community? Will these principles include protections for consumers and households which form the foundation of economic prosperity in our country as well as other countries?A.10. In a statement released following their November 15 meeting, the G-20 Heads of State articulated five key principles that will govern efforts by the official sector to reform the global financial system. These principles include strengthening transparency and accountability of financial markets and financial institutions, enhancing sound regulation, promoting integrity in financial markets, reinforcing international cooperation, and reforming international financial institutions. These efforts are constructive and should help to make the global financial system more robust and resilient. The Federal Reserve is working with its counterparts in the G-20 to identify and implement specific measures that will contribute to achieving these five principles. Initiatives to protect consumers and households are central to these efforts. The statement from the G-20 Heads of States emphasized that bolstering consumer protection is an essential step toward protecting the integrity of global financial markets. Consumers and households benefit both directly and indirectly as the financial system becomes stronger, better regulated, and more transparent.Commercial Paper Funding FacilityQ.11. What real assets are securing loans made under the CPFF to special purpose vehicles?A.11. The loans made under the CPFF to the special purpose vehicle (SPV) are collateralized by the highly rated commercial paper purchased by, and the fees collected by, the SPV.Q.12. What has the Federal Reserve done to clarify the effect of the CPFF on the daily rates reported in the Board's H-15 data release? What has the Board done to make clear that the support provided by the CPFF has altered the overall commercial paper rate? Does the H-15 data still represent an actual market rate, without credit enhancement by the CPFF or any other recent government action?A.12. On November 5, 2008 we added the following footnote to the H-15 release: Financial paper that is insured by the FDIC's Temporary Liquidity Guarantee Program is not excluded from relevant indexes, nor is anyfinancial, nonfinancial, or asset-backed commercial paper that may be directly or indirectly affected by one or more of the Federal Reserve's liquidity facilities. Thus the rates published after September 19, 2008, likely reflect the direct or indirect effects of the new temporary programs and, accordingly, likely are not comparable for some purposes to rates published prior to that period. The commercial paper rates published on the H-15 release have and continue to be a reflection of actual transactions that take place in the U.S. commercial paper market. We have never screened out transactions with third-party credit enhancements.Q.13. What analysis has the Federal Reserve undertaken to determine which markets usually use the 90-day commercial paper rate in conducting their business? Which of the markets, if any, did the Fed determine use this rate regularly in their business operation? What steps, if any, has the Federal Reserve taken to assure that the actions to lower the costs of issuing commercial paper are not having an adverse impact on other markets which are pegged to the 90-day financial commercial paper? Was a similar analysis conducted with respect to possible implications for markets that use other short term (under 365-day) commercial paper as a result of the establishment of the CPFF? What steps, if any, has the Federal Reserve taken to assure that the actions to lower the costs of issuing commercial paper is not having an adverse impact on those other markets?A.13. By law, the reimbursement rates on student loans are tied to the 90-day financial CP rate. In addition, dealers report that some financial contracts (e.g., derivatives) settle on certain CP rates published by the Federal Reserve. The link of the reimbursement rate on student loans to the 90-day financial CP rate has become problematic for student lenders, because their cost of funds tends to be tied to Libor, and the spread between Libor and the fmancial CP rate has moved against them. Importantly, the wider spread likely reflects pressures on the Libor rate as well as the CP rate. In addition, this spread first widened a few weeks before the CPFF began operation. To ensure that market participants fully understand our methodology for calculating CP rates, we published the following announcement on the Federal Reserve's commercial paper website on November 5, the first paragraph of which was also added (as already mentioned in our response to Question 11) as a footnote to the Federal Reserve's H-15 release: CHRG-110shrg50420--264 Mr. Mulally," Yes, we believe we have sufficient liquidity at the current time, but we absolutely support the oversight board concept. Senator Crapo. And when you talk about the oversight board, are you also talking about a board with the authority to literally impose restructuring conditions as a Chapter 11 court could? " CHRG-111hhrg48674--43 Mr. Bernanke," Two comments. The first is when we get involved in a ``too big to fail'' situation, usually the terms are much more onerous and difficult. For example, with AIG we imposed much tougher conditions than we would on an average bank taking capital from the TARP. The second comment repeats what I said earlier: Too big to fail is an enormous problem. We are very unhappy with this problem, and it should be a top priority to fix it as we go forward so the situation doesn't arise again. " FOMC20080130meeting--299 297,MR. KROSZNER.," Thank you very much. I also support alternative B. I think by any measure 125 basis points of easing within a month is a lot and perhaps it is a nearly unprecedented level of insurance that this Committee has purchased in such a short period of time. But I think it makes sense to have done it in these circumstances because we have the risk of a substantial tightening of credit and financial market conditions. There are still lots of shoes that may be left to drop and, in Nellie Liang's great phrase yesterday, ""unplanned asset expansions can occur."" Just today we heard that UBS increased by $4 billion the report of their expected losses from what they reported last month, and that is not their final report. They're not going to come out with the final numbers for another month, and so it's certainly conceivable that more could be there. The SocGen situation is obviously another thing that is potentially unsettling, and so I think it's very important to be buying some insurance, particularly when the slow-burn scenario that I've talked about for a long time is the one that I see as the most likely. There is not going to be just some immediate credit crunch or some immediate problem of impairment of capital at an institution. But just given the increase in the cost of raising capital, given the difficulty of getting things off the books, given that other things have to come on, or given just that the old securitization machines that at a given level of capital sustained a very high level of activity, which can't be done now because you can't get the things off the books, the machine can't churn at the same rate that it did even with the same amount of capital. Then with all these other challenges, we have to be wary of that. So the fragility is still there. As we talked about before, we had some dramatic improvements in October, through early November of last year, and suddenly they reversed, and I just don't feel comfortable that I understand where those went. That said, however, I think the very recent data that we have gotten provide just a glimmer of hope. I mean, we've had relatively low claims numbers. The ADP number was relatively low. I'm not sure how much information content is in that, but with the claims number it makes a notimplausible case that there wouldn't be a dramatic negative number in the employment report and potentially it could be on the positive side. I don't think GDP is quite so miraculous, as we heard the very humble Dave Stockton tell us that they nailed it. But also look at some of the places in which there was some weakness now that may come up next quarter. Over the next couple of quarters probably we're going to see a payback in government spending, whether it's through direct stimulus or through more expenditures on the military. The advance durable goods number, which no one really mentioned, was on the positive side. I don't want to put too much weight on that, but it suggests that there are at least some mixed signals going forward. So I think that means that we need to leave our options open. We need to worry about those downside risks, but we shouldn't dismiss the possibility that the forecast that Dave and the team have put out not only has nailed it for this quarter but also has not done such a bad job for the quarters going forward. That means we have to think a lot about what we want to say in the statement. How do we get that balance right? Clearly, it's important that we take out the word ""appreciable,"" and the markets will see that. The concern that President Fisher raised is a real one. If we continue to talk about ""appreciable risks"" after 125 basis points of cutting in a month, I think that would be unsettling to market participants. But I think the markets are expecting us to take that back. Actually if I could just for a moment get clarification from President Yellen. My understanding was that what she suggested about the change to the fourth paragraph and the assessment of risk was to change only the last sentence back to the December 11 statement. " FOMC20070807meeting--126 124,MR. PLOSSER.," Thank you, Mr. Chairman. I am certainly comfortable with maintaining the fed funds rate where it is, so I’m supportive of that. I think the real key here is language. What are we trying to convey to the markets? How far can we go, acknowledging what many people share—a sense of some increased risk—without creating another set of concerns in the marketplace? So the language is the tricky piece here. I’ve waffled a bit in my feelings about this. I’m inclined to be about where I think Bill Poole and Janet Yellen are—moving the downside risks into paragraph 2 as opposed to putting them in the assessment of risk. I would be supportive of that tone. Also, in response to some of Jeff’s comments in his earlier memo on this, I actually prefer the language of repricing of risk rather than of tightening credit conditions simply because it emphasizes that this is partly a relative price adjustment that is going on. But I don’t want to take a strong stand on that. Only one other word concerns me, and I’d like to raise the issue here. In paragraph 3, which nobody has talked about yet, in the first sentence, “readings on core inflation have been relatively subdued in recent months” is a change in the language from our previous statement, which says, “improved modestly recent months.” I worry a little about the word “subdued” because I think it becomes very close to making some kind of normative judgment about the level of inflation that we are happy with. I’m uncomfortable about that particular change in the language because it, again, might imply some normative statement without the Committee’s agreeing on what we view as being subdued or not. So I’d like to suggest that we change that back to what it was before because, if we want to convey stability and some continuity here, there are places to change, there are places not to change, and I would rather change fewer words than more words going forward. That would be the only additional suggestion I would make. Thank you, Mr. Chairman." CHRG-110hhrg46593--58 The Chairman," Thank you, Madam Chairwoman. I would note that, in the TARP, there is explicit authorization to provide funding for servicers in appropriate context. So we think it is embraced. The gentleman from California, Mr. McCarthy. Mr. McCarthy of California. Thank you, Mr. Chairman. If I could just follow up one moment with the chairwoman. How many loans did you provide in the IndyMac situation, and what was the value overall? Ms. Bair. We had about 40,000 delinquent loans that were eligible. There were 60,000 delinquent loans total, but about 20,000 of those either were investor-owned or had been abandoned or were just too far gone. They were in bankruptcy or the homeowners had given up. So about 40,000 eligible. As I indicated in my written testimony, we will do loan modification proposals for about 30,000 of those 40,000. The letters are still going out. We have completed modifications of about 5,000, with several thousand more in process. We do verify income-- Mr. McCarthy of California. And how long does that take you? What is the timeframe from start to finish? Ms. Bair. We started in late August with the first mailing of 7,000 and have made mailings throughout the months since. When the loan modification proposal goes out, it specifically says, ``This is your current mortgage payment. We are going to reduce your mortgage payment by `X' amount.'' The average is about $380 a month. The proposal will go on to say, ``If you want this loan modification, send us a check for your first month's payment, and sign this form that allows us to document income through looking at your tax return.'' It is a very simple, streamlined procedure. It is easy for borrowers to understand. It is not a general, you know, ``Call us, we are here to help you.'' Instead, it says, this is the loan modification that you will get. We have had a very strong response rate. Of the first mailing we did in late August, over 70 percent of the borrowers have responded. But it still takes time. You still have to document income. You still have to go and look at the tax return, and you have to establish that borrower contact. The income verification takes the most time. Mr. McCarthy of California. Mr. Secretary, I understand you have to modify, things change, and the latest is: no longer planning to purchase troubled assets. Have you taken a look since the last 6 weeks about part of the plan in there, the insurance program? Have you pursued that in any further way? " CHRG-111hhrg52406--236 Mr. Wilson," Well, some of the parts of our industry have different needs and different circumstances, and with basic conditions of enhanced consumer protections and to retain State-based, we could support the concept. Ms. Speier. All right. Thank you. I yield back. Mr. Miller of North Carolina. Thank you, Ms. Speier. Mr. Sherman for 5 minutes. " CHRG-111hhrg58044--12 Mr. Manzullo," Thank you, Mr. Chairman. There is a distinction between people who incur medical debt and those who go out and charge vacations and consumer items. I practiced law for 22 years and have been through probably 1,000 bankruptcies. In several of those cases, the people I put into bankruptcy either exhausted their insurance or had no insurance and they filed bankruptcy not because they wanted to, not because they did anything intentionally, but simply because they could not pay off their medical bills. I talked to two colleagues of mine in Rockford, Illinois, who specialize in bankruptcy. The two of them have been through 30,000 bankruptcies together. One had the record for credit card debt, $140,000. Mr. Chairman, it was all medical expenses. We have to draw a distinction here between people who because of their spendthrift outrageous uncreditworthy conduct go out and buy things just because they want them, and people who are caught up, especially today, without insurance or lack of insurance or many times very high deductibles, co-pays, etc. I am a sponsor of this bill because it is the right thing to do, especially with so many credit card companies, the case that my wife and I had on a simple $150 coat that was put on layaway, it took us 4 years to clear that. It was not until I threatened a lawsuit under the Fair Credit Reporting Act that the credit companies finally backed off on it. Credit card reporting companies do a job and I understand what they are doing, but for people who are the unfortunate victims-- " CHRG-110hhrg44901--53 Mr. Bernanke," Well, there has been a problem in that many banks that have suffered losses from mortgage credit and therefore have had their capital reduced, they either have to raise more capital or if they don't do that, they have to shrink their balance sheets or at least be reluctant to make new loans. So there is some risk of that, that it would spill over to other kinds of credit. In fact we have seen credit tightening in a number of dimensions. Of course there is another factor as well, which is as the economy slows it is natural for banks to be more cautious in their lending because with a slower economy, credit risks tend to rise. So that is a very important issue. We want to be sure that banks are sound and that they have enough capital so that they cannot just be safe and sound, which of course is critical, but beyond that so that they can expand credit in a safe and sound way to promote the recovery and strength of the economy. Ms. Velazquez. Mr. Chairman, every day we hear stories about small businesses being impacted by the credit crunch. And the Fed used to provide the Survey of Small Business Finances. And you have been critical to many policy decisions both at the Federal Reserve and here in Congress. If the survey is discontinued, what alternative sources of information will your agency use to make its report to Congress on the availability of credit to small businesses? " CHRG-111shrg50815--117 CLAYTON Q.1. Access to Credit: A potential outcome of the new rules could be that consumers with less than a 620 FICO score could be denied access to a credit card. Such an exclusion could affect 45.5 million individuals or over 20 percent of the U.S. population. Without access to traditional credit, where do you believe that individuals would turn to finance their consumer needs? A.1. It is likely that consumers perceived to have higher levels of risk--including those that are new to credit--will bear the brunt of credit reductions resulting from the rule. Thus, as noted in your question, the inability to price risk effectively may well mean less access to credit for very deserving individuals just because card issuers are unsure of the credit risk involved and will not be able to price for that risk as it becomes more apparent. As the credit needs of these individuals are unlikely to disappear--and, in fact, may actually increase due to exigent economic circumstances, e.g., unemployment--these consumers will likely be forced to turn to non-federally regulated lenders including payday lenders and loan sharks. Q.2. Risk-Based Pricing: Banks need to make judgments about the credit-worthiness of consumers and then price the risk accordingly. Credit cards differ from closed-end consumer transactions, such as mortgages or car loans, because the relationship is ongoing. I am concerned by the Federal Reserve's new rules on risk-based repricing for a couple of reasons. First, without the ability to price for risks, banks will be forced to treat everyone with equally stringent terms, even though many of these individuals perform quite differently over time. Second, without a mechanism to reprice according to risk as a consumer's risk profile changes, many lenders will simply refuse to extend credit to a large portion of the population. Do you believe that consumers will have access to less credit and fewer choices because of the Fed's new rule? If so, is this a desirable outcome? A.2. The new rule will affect every aspect of the credit card business, from how cards are funded, to how they are priced, to how they are marketed, and to how credit is allocated among customers of differing credit histories and risk. Because the rules are so strong, card lenders may have to increase interest rates in general, lower credit lines, assess more annual fees, and reduce credit options for some customers. The full impact of these changes will likely not be fully known for several years as business practices are changed and as the credit availability works its way through the economy. The new rule may also lead to higher interest rates or fees (such as annual fees) for all cardholders in order to compensate for the inability to price risk effectively. Thus, the least risky borrowers must now bear the cost for higher risk borrowers because the higher-risk borrowers will no longer bear the full cost of the exposure they pose to lenders. It may also be the case that payment allocation requirements will lead to the elimination of low-rate balance transfers that consumers and small businesses previously used to lower overall debt costs. Simply put, the sum total of all these rules will likely lead to reduced access to credit and higher prices to all consumers, in addition to many fewer choices on card products. We do not believe this is a desirable outcome for both consumers and the broader economy. Q.3. Safety and Soundness and Consumer Protection: I believe firmly that safety and soundness and consumer protection go hand-in-hand. One needs only to look at the disaster in our mortgage markets, for clear evidence of what happens when regulators and lenders divorce these two concepts. A prudent loan is one where the financial institution fully believes that the consumer has a reasonable ability to repay. Do you agree that prudential regulation and consumer protection should both be rigorously pursued together by regulators? A.3. A system linking bank regulation and consumer protection forces more balanced supervision without the turf battles and inefficiency inherent in bifurcated jurisdiction. The two are highly integrated, and that one aspect cannot and should not be divorced from the other. This ensures that, for example, safe and sound lending would not be compromised by fee and rate restrictions envisioned by a consumer regulator only concerned with driving consumer costs down unencumbered by a need to consider the impact such restrictions may have on adequate return. Q.4. Subsidization of High-Risk Customers: I have been receiving letters and calls from constituents of mine who have seen the interest rates on their credit cards rise sharply in recent weeks. Many of these people have not missed payments. Mr. Clayton, in your testimony you note that credit card lenders have increased interest rates across the board and lowered credit lines for many consumers, including low-risk customers who have never missed a payment. Why are banks raising interest rates and limiting credit apparently so arbitrarily? Does this result in low-risk customers subsidizing people who are high-risk due to a track record of high-risk behavior? A.4. The rising interest rates and limitations on credit are due primarily to three factors. First, in the present challenging economic time, lenders are being more careful. Delinquencies on credit card accounts have significantly increased as a result of rising unemployment and uncertainty in the economy. This substantial increase in repayment risk affects the ability of lenders to make new loans, and requires companies to carefully evaluate and minimize their risk across the board so that they may stay in business and continue to make new loans. Second, funding costs have increased dramatically in the secondary market, which funds nearly half (or approximately $450 billion) of all credit card loans made by commercial banks. Investors are extremely sensitive to changes in the terms and conditions of the underlying asset, as has been evident in the current market, where investors have shunned nearly all forms of asset-backed securities over fears in the underlying economy. This drives up the cost of funding new credit, and leads to higher costs to consumers. Third, all businesses are concerned for the future, as borrowers' ability to repay may become severely compromised. This is particularly true with respect to credit card loans, which are open-end lines of credit, unsecured and greatly subject to changing risk profiles of borrowers. Banks need to ensure they will be paid for the risks they have taken in credit card loans; otherwise they will not be able to continue to make loans. As a result, many institutions must raise rates and reduce risk exposure in order to continue to lend. This results in all borrowers having to bear the cost of higher risk generally, a trend that will be exacerbated by the new regulations that limit the ability of lenders to price particular individuals for the risk they pose. Q.5. Effects on Low-income Consumers: I want to put forward a scenario for the witnesses. Suppose a credit card customer has a low income and a low credit limit, but a strong credit history. They use their credit card for unexpected expenses and pay it off as soon as possible, never incurring late fees. With the new regulations approved by the Federal Reserve, banks will be restricted in their use of risk-based pricing. This means our cardholder could see his or her interest rates and fees increased to pay for the actions of other card holders, many of whom have higher incomes. Do any of the witnesses have concerns that moving away from risk-based pricing could result in the subsidization of credit to wealthy yet riskier borrowers, by poorer but lower-risk borrowers? A.5. Reducing the ability of lenders to manage risk forces them to apply more general models to all account holders. The consequence of applying general models is that all account holders pay somewhat equally. Lower-risk borrowers at all income levels bear the brunt of this burden. Q.6. Role of Securitization: It is my understanding that during the height of the credit boom nearly half of all credit card debt outstanding was held in securitization trusts. Over the last 18 months much of the securitization market has been severely constrained. The Federal Reserve wants to revive the securitization markets through the Term Asset Lending Facility (TALF), but it is not yet operational. How important is a rebound in the securitization market to the availability of consumer credit? In other words, how much greater will the contraction be in the credit card space without securitization? A.6. The rebound in the securitization market is a critical component to the availability of credit in our economy. Credit cards are funded from two primary sources: deposits and secondary market funding, each accounting for about half--approximately $0.5 trillion dollars--of the total funding of card loans to consumers. Funding in the secondary market relies on investors' willingness to hold securities that are backed by credit card receivables. Any change in the terms of issuance can greatly impact the receptivity of investors to holding these securities. If investors perceive that there is greater risk, they are less likely to hold these securities, or may require significantly higher interest rates or other enhancements to compensate them for the risk. This means that less funding will be available, and if available, more costly. This translates into less credit available at higher cost to customers. It is hard to speculate as to the extent of greater contraction caused by a non-functioning securitization market, as lenders will have to turn to a limited number of alternative--and higher priced--funding mechanisms. However, we do believe the additional contraction would be very significant, and is reflected in the Administration's concern over this important aspect of the marketplace. ------ RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM JAMES C. FOMC20081216meeting--256 254,MR. MADIGAN.," On the former, just a guess, I would think that without any target federal funds rate--and given the well-known issues that we have been discussing about pressures on banks--it is possible that the prime rate would not be reduced by the full extent of the implicit reduction in the money market conditions that the FOMC would be targeting. But I don't really have a good sense as to what would happen quantitatively. " CHRG-110hhrg38392--69 Mr. Bernanke," Well, I do not think it is very surprising to say that would be a fairly disruptive event if it happened very quickly. As I said in February, I do think it is important for Congress to think through how many immigrants they would like to have and under what conditions, because it is important to try to create some certainty and some ability to forecast what workforces are going to look like. " FOMC20081029meeting--38 36,CHAIRMAN BERNANKE.," Let me say just a couple of quick things. One is that this would require renegotiating the whole thing from the beginning, and we would like, if possible, to do this tomorrow with the IMF. The second point I would make is that we do have considerable security, and we will be dispensing this--under strict conditions--in limited tranches. I think we could monitor pretty well what was going on. But the point is well taken. President Plosser. " FOMC20070918meeting--326 324,MR. WARSH.," Thank you, Mr. Chairman. Very briefly, when I think back about a week ago to maybe one of the darker days that we’ve had in the past six weeks, there were so many more institutions that were funding themselves on an overnight basis that it wouldn’t take much imagination for us to get very fearful very soon if there were some kind of shock that made it impossible or much more difficult for them to fund themselves twenty-four hours later. So I think the ACF would have held great promise then to be useful in addressing some of the headline risks that could very quickly have had systemic implications. I think the ACF holds great promise now. I’ll highlight only one question, which is timing. I share the view put forth by President Stern that, to the extent we see these markets improving on their own terms, which is something we’ve seen in recent trading days, we wouldn’t want to do anything to stop that momentum. If we had hit the button today, it may well be that they would have had to take stock of this new instrument and compare it to the other alternatives they have, and that improvement could have potentially been delayed. On the other hand, if we wait until these markets deteriorate to where they were a week ago, the efficacy of hitting the button then would also be less than ideal. So my own sense on timing—and it’s something that the Chairman will, I think, brief us all on if we get to that September 18, 2007 163 of 188 point—is to the extent that we see that momentum has stopped and we see the ground weakening below us, then we might have to make a risk-adjusted call at that point. I don’t think it will be a very easy or a very apparent one. But on balance, I think that the macroeconomic possibilities are pretty scary, which makes me suggest that we would lean forward on this. Thank you, Mr. Chairman." CHRG-111shrg56415--244 PREPARED STATEMENT OF JOSEPH A. SMITH, JR. North Carolina Commissioner of Banks, on behalf of the Conference of State Bank Supervisors October 14, 2009INTRODUCTION Good afternoon, Chairman Johnson, Ranking Member Crapo, and distinguished members of the Subcommittee. My name is Joseph A. Smith, Jr. I am the North Carolina Commissioner of Banks and the Chairman of the Conference of State Bank Supervisors (CSBS). Thank you for the opportunity to testify today on the condition of the banking industry. In the midst of a great deal of discussion about reform and recovery, it is very important to pause to assess the health of the industry and the factors affecting it, for good and ill. My testimony today will present the views of state bank supervisors on the health of the banking industry generally and the banks we oversee in particular--the overwhelming majority of which are independent community banks. The states charter and regulate 73 percent of the nation's banks (Exhibit A). These banks not only compete with the nation's largest banks in the metropolitan areas, but many are the sole providers of credit to less populated and rural areas (Exhibit B). We must remember 91 percent of this country's banks have less than $1 billion in assets but share most of the same regulatory burdens and economic challenges of the largest banks which receive the greatest amount of attention from the Federal Government. Community and regional banks are a critical part of our economic fabric, providing an important channel for credit for consumers, farmers, and small businesses. I will address: the key challenges that state-chartered banks face, regulatory policies that we are pursuing to improve supervision and the health of the industry, and recommendations to improve the regulation of our banks and ultimately the health of the industry.CONDITION OF THE BANKING INDUSTRY While the economy has begun to show signs of improvement, there are still many areas of concern. Consumer confidence and spending remains low, deficit spending has soared, and unemployment rates continue to slowly tick upward. The capital markets crisis, distress in the residential and commercial real estate markets, and the ensuing recession have greatly weakened our nation's banking industry. And despite recent positive developments, the banking industry continues to operate under very difficult conditions. While there are pockets of strength in parts of the state bank system, the majority of my fellow state regulators have categorized general banking conditions in their states as ``gradually declining.'' Not surprisingly, the health of banks is directly affected by the economic conditions in which they operate. Times of economic growth will usually be fueled by a banking industry with sufficient levels of capital, a robust and increasing volume of performing loans, ample liquidity, and a number of new market entrants, in the form of de novo institutions. Conversely, this recession is characterized by a banking industry marred by evaporating capital levels, deteriorating and increasingly delinquent loans, liquidity crunches, and a steady stream of bank failures. The Federal Deposit Insurance Corporation (FDIC) reports in its most recent Quarterly Banking Profile that the banking industry suffered an aggregate net loss of $3.7 billion in the second quarter of 2009. These losses were largely caused by the increased contributions institutions made to their loan-loss provisions to counter the rising number of non-performing loans in their portfolios and realized losses. Further, additional writedowns in the asset-backed commercial paper portfolios and higher deposit insurance assessments impacted banks' earnings significantly.\1\--------------------------------------------------------------------------- \1\ FDIC Quarterly Banking Profile, Second Quarter 2009: http://www2.fdic.gov/qbp/2009jun/qbp.pdf.--------------------------------------------------------------------------- Across the country, my colleagues are experiencing deteriorating credit quality in their banks, which is straining earnings and putting extreme pressure on capital. Deterioration in credit quality is requiring greater examination resources as regulators evaluate a higher volume of loans. Concentrations in commercial real estate (CRE) loans in general, and acquisition, development, and construction (ADC) loans in particular, are posing the greatest challenge for a significant portion of the industry. This is an important line of business for community and regional banks. Banks with less than $10 billion in assets comprise 23 percent of total bank assets, but originate and hold 52 percent of CRE loans and 49 percent of ADC loans by volume. Reducing the concentrations that many of our institutions have in CRE lending is an important factor in restoring them to health; however, it is our view that this reduction needs to be done in a way that does not remove so much credit from the real estate market that it inhibits economic recovery. Striking an appropriate balance should be our goal. Deteriorating credit quality has a direct and destructive effect on bank capital. Reduction in capital, in turn, has a direct and destructive effect on a bank's liquidity, drying up its sources of funding from secondary sources, including capital markets, brokered deposits, home loan and bankers' banks and the Federal Reserve. This drying up of liquidity has been a significant challenge for a substantial number of the failures.CAPITAL IS KING As we entered the financial crisis, we touted the overall strong capital base of the industry, especially compared to previous periods of economic stress. While this was true, banks are highly leveraged operations, and when losses materialize, capital erodes quickly. While this is true for all institutions, it is more pronounced in our largest banks. According to the FDIC, as of December 31, 2007, banks over $10 billion in assets had an average leverage capital ratio of 7.41 percent. This was 200 basis points (b.p.) less than banks with assets between $1 billion and $10 billion; 256 b.p. less than banks with assets between $100 million and $1 billion; and an astonishing 610 b.p. less than banks with assets less than $100 million. As the financial crisis was unfolding and the serious economic recession began, these numbers show our largest institutions were poorly positioned, leading to the extraordinary assistance by the Federal Government to protect the financial system. Even with this assistance, this differential continues today with the largest institutions holding considerably less capital than the overwhelming majority of the industry. Last year, the Federal Government took unprecedented steps to protect the financial system by providing capital investments and liquidity facilities to our largest institutions. Financial holding company status was conferred on a number of major investment banks and other financial concerns with an alacrity that was jaw-dropping. We trust the officials responsible took the action they believed necessary at that critical time. However, Federal policy has not treated the rest of the industry with the same expediency, creativity, or fundamental fairness. Over the last year, we have seen nearly 300 community banks fail or be merged out of existence, while our largest institutions, largely considered too big to fail, have only gotten bigger. State officials expect this trend to continue, with an estimated 125 additional unassisted, privately negotiated mergers due to poor banking conditions. Additional capital, both public and private, must be the building block for success for community and regional banks. While TARP has provided a source of capital for some of these institutions, the process has been cumbersome and expensive for the community and regional banks, whether they actually received the investment of funds or not. There has been a lack of transparency associated with denial of a TARP application, which comes in the form of an institution being asked to withdraw. This should of deep concern to Congress. If TARP is to be an effective tool to strengthen community and regional banks, the Treasury must change the viability standard. We should provide capital to institutions which are viable after the TARP investment. Expanded and appropriate access to TARP capital will go a long way to saving the FDIC and the rest of the banking industry a lot of money. To date, this has been a lost opportunity for the Federal Government to support community and regional banks and provide economic stimulus. There are positive signs private capital may be flowing into the system. For the 6 months ending June 30, 2009, over 2,200 banks have injected $96 billion in capital. While capital injections were achieved for all sizes of institutions, banks with assets under $1 billion in assets had the smallest percentage of banks raising capital at 25 percent. There has been and, to our knowledge, there still is a concern among our Federal colleagues with regard to strategic investments in and acquisitions of banks, both through the FDIC resolution process and in negotiated transactions. While these concerns are understandable, we believe they must be measured against the consequence of denying our banks this source of capital. It is our view that Federal policy should not unnecessarily discourage private capital from coming off the sidelines to support this industry and in turn, the broader economy.SUPERVISION DURING THE CRISIS There are very serious challenges facing the industry and us as financial regulators. State regulators have increased their outreach with the industry to develop a common understanding of these challenges. Banks are a core financial intermediary, providing a safe haven for depositors' money while providing the necessary fuel for economic growth and opportunity. While some banks will create-and have created-their own problems by miscalculating their risks, it is no surprise that there are widespread problems in banks when the national economy goes through a serious economic recession. We will never be able, nor should we desire, to eliminate all problems in banks; that is, to have risk-free banking. While they are regulated and hold the public trust, financial firms are largely private enterprises. As such, they should be allowed to take risks, generate a return for shareholders, and suffer the consequences when they miscalculate. Over the last year, we have watched a steady stream of bank failures. While unfortunate and expensive, this does provide a dose of reality to the market and should increase the industry's self-discipline and the regulators' focus on key risk issues. In contrast to institutions deemed too big to fail, market discipline and enhanced supervisory oversight can result in community and regional banks that are restructured and strengthened.Recognizing the Challenges The current environment, while providing terrific challenges with credit quality and capital adequacy, has also brought an opportunity for us to reassess the financial regulatory process to best benefit our local and national economies. To achieve this objective, it is vital to step back and make an honest assessment of our regulated institutions, their lines of business, management ability, and capacity to deal with economic challenges. This assessment provides the basis for focusing resources to address the many challenges we face. With regard to financial institutions, as regulators we must do a horizontal review and engage in a process of ``triage'' that divides our supervised entities into three categories: I. Strong II. Tarnished III. Weak Strong institutions have the balance sheets and management capacity to survive, and even thrive, through the current crisis. These institutions will maintain stability and provide continued access to credit for consumers. Further, these institutions will be well-positioned to purchase failing institutions, which is an outcome that is better for all stakeholders than outright bank failure. We need to ensure these institutions maintain their positions of strength. Tarnished institutions are under stress, but are capable of surviving the current crisis. These institutions are where our efforts as regulators can make the biggest difference. Accordingly, these institutions will require the lion's share of regulatory resources. A regulator's primary objective with these institutions should be to fully and accurately identify their risks, require generous reserves for losses, and develop the management capacity to work through their problems. We have found that strong and early intervention by regulators, coupled with strong action by management, has resulted in the strengthening of our banks and the prevention of further decline or failure. By coordinating their efforts, state and Federal regulators can give these banks a good chance to survive by setting appropriate standards of performance and avoiding our understandable tendencies to over-regulate during a crisis. Weak institutions are likely headed for failure or sale. While this outcome may not be imminent, our experience has shown that the sooner we identify these institutions, the more options we will have to seek a resolution which does not involve closing the bank. It simply is not in our collective best interest to allow an institution to exhaust its capital and to be resolved through an FDIC receivership, if such an action can be avoided. Institutions we believe are headed toward almost certain failure deserve our immediate attention. This is not the same as bailing out, or propping up failing institutions with government subsidies. Instead, as regulators our goal is an early sale of the bank, or at least a ``soft landing'' with minimal economic disruption to the local communities they serve and minimal loss to the Deposit Insurance Fund.AREAS REQUIRING ATTENTION This is the time for us to be looking forward, not backwards. We need to be working to proactively resolve the problems in the banking industry. To do this, we need to ensure our supervisory approach is fair and balanced and gives those banks which deserve it the chance to improve their financial positions and results of operations. The industry and regulators must work together to fully identify the scope of the problems. However, I believe we need to consider the response which follows the identification. We should be tough and demanding, but the response does not need to send so many banks toward receivership. A responsive, yet reasonable approach, will take a great deal of time and effort, but it will result in less cost to the Deposit Insurance Fund and benefit communities and the broader economy in the long-run. I would like to highlight a few areas where I have concerns.Increase Access to Capital First, as discussed earlier, we need to allow capital to flow into the system. There is a significant amount of capital which is seeking opportunities in this market. We need to encourage this inflow through direct investments in existing institutions and the formation of new banks. To the extent that private investors do not themselves have bank operating experience or intend to dismantle institutions without consideration of the social and economic consequences, such shortcomings can and should be addressed by denial of holding company or bank applications or through operating restrictions in charters or regulatory orders. Where private equity groups have employed seasoned management teams and proposed acceptable business plans, such groups should be granted the necessary regulatory approvals to invest or acquire. While we cannot directly fix the capital problem, we should ensure the regulatory environment does not discourage private capital.Expedite Mergers Second, we need to allow for banks to merge, especially if it allows us to resolve a problem institution. Unfortunately, we have experienced too many roadblocks in the approval process. We need more transparency and certainty from the Federal Reserve on the process and parameters for approving mergers. To be clear, I am not talking about a merger of two failing institutions. Facilitating the timely merger of a weak institution with a stronger one is good for the system, good for local communities, and is absolutely the least cost resolution for the FDIC.Brokered Deposits Third, over the last several years the industry has explored more diversified funding, including the use of brokered deposits. Following the last banking crisis, there are restrictions for banks using brokered deposits when they fall below ``well capitalized.'' I appreciate the efforts of FDIC Chairman Bair in working to provide more consistency and clarity in the application of this rule. However, I am afraid the current approach is unnecessarily leading banks to fail. We allowed these banks to increase their reliance on this funding in the first place, and I believe we have a responsibility to assist them in gradually unwinding their dependency as they work to clean up their balance sheet. My colleagues have numerous institutions that could have benefited from a brokered deposit waiver granted by the FDIC. As noted above, many of the recent failures of community and regional banks have been the result of a sudden and precipitous loss of liquidity.Open Bank Assistance Fourth, the FDIC is seriously constrained in providing any institution with open bank assistance. We are concerned that this may be being too strictly interpreted. We believe there are opportunities to provide this assistance which do not benefit the existing shareholders and allows for the removal of bank management. This is a much less disruptive approach and I believe will prove to be much less costly for the FDIC. The approach we suggest was essentially provided to Citibank and Bank of America through loan guarantees without removing management or eliminating the stockholders. As discussed previously, we believe that the Capital Purchase Program under TARP can be a source of capital for transactions that restructure banks or assist in mergers to the same effect. We are not suggesting that such support be without conditions necessary to cause the banks to return to health.Prompt Corrective Action Finally, Congress should also investigate the effectiveness of the Prompt Corrective Action (PCA) provisions of the Federal Deposit Insurance Corporation Improvement Act in dealing with problem banks. We believe there is sufficient evidence that the requirements of PCA have caused unnecessary failures and more costly resolutions and that allowing regulators some discretion in dealing with problem banks can assist an orderly restructuring of the industry.LOOKING FORWARD There will be numerous legacy items which will emerge from this crisis designed to address both real and perceived risks to the financial system. They deserve our deliberate thought to ensure a balanced and reasoned approach which provides a solid foundation for economic growth and stability. The discussions around regulatory reform are well underway. We would do well to remember the instability of certain firms a year ago which put the U.S. financial system and economy at the cliff's edge. We must not let the bank failures we are seeing today cloud the real and substantial risk facing our financial system--firms which are too big to fail, requiring extraordinary government assistance when they miscalculate their risk. We need to consider the optimal economic model for community banks, one that embraces their proximity to communities and their ability to engage in high-touch lending. However, we must ensure lower concentrations, better risk diversification, and improved risk management. We need to find a way to ensure banks are viable competitors for consumer finance and ensure they are positioned to lead in establishing high standards for consumer protection and financial literacy. We must develop better tools for offsite monitoring. The banking industry has a well established and robust system of quarterly data reporting through the Federal Financial Institutions Examination Council's Report of Condition and Income (Call Report). This provides excellent data for use by all regulators and the public. We need to explore greater standardization and enhanced technology to improve the timeliness of the data, especially during times of economic stress. Over the last several years, the industry has attracted more diversified sources of funding. This diversification has improved interest rate risk and liquidity management. Unfortunately, secured borrowings and brokered deposits increase the cost of resolution to the FDIC and create significant conflicts as an institution reaches a troubled condition. We need to encourage diversified sources of funding, but ensure it is compatible with a deposit insurance regime. We need to consider how the Deposit Insurance Fund can help to provide a countercyclical approach to supervision. We believe Congress should authorize the FDIC to assess premiums based on an institution's total assets, which is a more accurate measure of the total risk to the system. Congress should revisit the cap on the Fund and require the FDIC to build the Fund during strong economic times and reduce assessments during period of economic stress. This type of structure will help the entire industry when it is most needed.CONCLUSION The banking industry continues to face tremendous challenges caused by the poor economic conditions in the United States. To move through this crisis and achieve economic stability and growth, Members of Congress, state and Federal regulators, and members of the industry must coordinate efforts to maintain effective supervision, while exercising the flexibility and ingenuity necessary to guide our industry to recovery. Thank you for the opportunity to testify today, and I look forward to any questions you may have. ______ FOMC20080318meeting--142 140,MR. STERN.," Thank you, Mr. Chairman. Well, as somebody said recently, there are no altogether good choices. I strongly support the recommendation and the language that goes with it. A couple of weeks ago I thought the funds rate probably should go to 2� percent. I got there basically by saying, well, given what I know about current conditions, the outlook, and everything, 3 percent is not a bad level. But there are a lot of things I don't know, and it's likely that some events are going to occur in the next couple of weeks or sometime in the future that may disturb things, and as a little insurance for that, 2� would be a good idea. Well, those events--I'm talking about Bear Stearns and other disruptions--occurred sooner rather than later, so it seems to me that we need to go to 2� and then ask ourselves whether we want some additional insurance. My answer to that is ""yes."" So I'm perfectly comfortable with taking the funds rate down � percentage point now. Does it strike the appropriate balance between our concerns about financial conditions and the outlook, and inflation and inflation expectations on the other side? I don't know. But as I said at the outset of this, I don't know that there are any altogether good choices. I think this is about as good as we can do under these circumstances. " CHRG-111shrg57319--559 Mr. Killinger," If market conditions were satisfactory and we could execute profitably on that---- Senator Levin. That is always true about market conditions, but your plan was, ``Our Home Loans group should complete its repositioning within the next 12 months and will be in a position to profitably grow its market share of Option ARM, home equity, subprime, and Alt A.'' Those are the high-risk loans. I am just reading your own words. Now, let us turn to Exhibit 34,\1\ which is an internal WaMu review by its Risk Mitigation and Mortgage Fraud Group. This is September 8, 2008. You are right here on the brink of going out of business, but that is not the point here that I am trying to read.--------------------------------------------------------------------------- \1\ See Exhibit 34, which appears in the Appendix on page 564.--------------------------------------------------------------------------- Take a look at the first finding. This is September 8, 2008. This is, I think, a couple weeks before you were taken over. The first finding of the review, page 3. I want to get back to all the fraud here, because it is one thing to say that you could not know with certainty that there was a housing bubble that was going to burst, even though you predicted it. The issue is not that you did not know when the housing bubble would burst. The problem is what did you know about what was going on in your own company in terms of how much fraud was going on. That becomes the issue that I want to focus on, the level of fraud and what you knew or did not know about that. Here is what you were told in 2008. This is September 8, 2008. ``The controls that are intended to prevent the sale of loans that have been confirmed by Risk Mitigation to contain misrepresentations or fraud are not currently effective.'' Now, that should have set off some alarm bells. Your fraud controls and misrepresentation controls are not effective. And it says, ``There is not a systemic process to prevent a loan in the Risk Mitigation Inventory and/or confirmed to contain suspicious activity from being sold to an investor.'' And then there is a test of 25 loans; 11 reflect a sale date after the completion of the investigation which confirmed fraud. That is going on inside your company. You cannot predict with certainty the bubble. But this is what is happening inside your company when you got that report. Maybe I should ask Mr. Rotella as well. You got this report. What was your reaction? " FOMC20080318meeting--118 116,VICE CHAIRMAN GEITHNER.," I guess another way to frame the question is, If we are reasonably successful in mitigating this adverse feedback dynamic in markets and the effects that has on financial conditions, would we still need to lower the nominal fed funds rate further to achieve the forecast laid out in the Board staff's Greenbook? " CHRG-110shrg50414--271 RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM JAMES B. LOCKHART IIIQ.1. Director Lockhart, I was pleased to see your recent statement affirming your support for the multifamily lending programs of Fannie Mae and Freddie Mac, and your intention not to sell the low income housing tax credit interests at either institution. As you know, Fannie and Freddie are the single most important sources of financing for affordable multifamily rental housing, vital to hundreds of thousands of low income families across the country. The GSEs provide valuable stability to multi-family rental housing by being active in this market all the time. Do you agree that this part of the enterprises' business is fulfilling their liquidity and stability missions, and that you will continue to support their financing of this housing, which overwhelmingly serves people below 100 percent of area median income, and is a significant contributor to Fannie Mae and Freddie Mac's regulatory housing goals?A.1. Yes. Fannie Mae and Freddie Mac historically have provided valuable stability to the multifamily market by maintaining a regular presence in the financing of such housing, and they should continue to do so. Such a presence, however, requires an innovative and market-oriented approach that reflects the current financial condition of the Enterprises themselves and the actual needs of the multifamily market.Q.2. Given the serious dislocation of the Low Income Tax Credit market in the absence of Fannie and Freddie investments, are you planning to permit the companies to reopen that business line as soon as practicable?A.2. While we recognize that LIHTC investments have provided significant assistance to affordable housing markets in the past, new investments in LIHTC are not economically attractive for the Enterprises when they are reporting losses. In their most recent quarterly financial statements, both Enterprises established valuation allowances for their deferred tax assets, which are indicative of their potential inability to realize future tax benefits associated with LIHTC investments. Part of what needs to be done to assist the LIHTC market is to broaden participation. Accordingly, FHFA has been working very hard with the Enterprises to determine how they can play a key role in achieving that goal. That involves the Enterprises looking at creative transaction structures, in consultation with FHFA, as well as conducting outreach to stakeholders, including housing advocates, lenders, and state and local housing finance agencies, with the goal of expanding the universe of these credits. FHFA's meetings with such groups have been regular, extensive, and productive, and are ongoing.Q.3. Last year HUD declared the regulatory housing goals ``infeasible'' for both enterprises because of market conditions. Since then, Congress has adopted a new approach to the calculation and measurement of the companies' housing goals, as well as added new ``duties to serve'' specific populations and markets. I'm sure you agree that given the current market and the companies' situation it is vitally important to reaffirm and clarify their housing goals requirements. What is your plan to quickly issue new regulations to execute these new provisions and ensure that both companies have clear direction in meeting these important requirements, and to publish clear guidance on what FHFA considers to be the important additional ``duties to serve'' under the statute?A.3. Given current market conditions, it is vitally important to reaffirm and clarify the Enterprises' requirements with respect to housing goals. FHFA has begun the process of reviewing housing goals for 2009 and will issue proposed goals for public comment in the first quarter of 2009. In addition, FHFA has begun the process of implementing regulations to establish new housing goals, as well as new ``duty to serve'' requirements, for 2010. We expect to issue a proposed regulation for public comment by the second quarter of 2009 and to issue a final regulation by the fourth quarter.Q.4. Over the years the GSEs have provided important services to populations that are especially hard to serve, such as Native Americans living on trust lands, and people with special needs. Fannie Mae also has provided lines of credit and equity and equity-like investment to community loan funds and community development lenders. These investments provide community-oriented lenders with more capital to support revitalization projects in come of America's hardest hit communities. They also have developed products such as Community Express and Modernization Express that help public agencies finance important public investments in housing. Do you agree that these specialized lending products are important extensions of their mission to serve low and moderate income people and underserved communities, and what role do you anticipate these specialized and targeted products will play in their future business?A.4. Specialized and targeting lending products have made a significant contribution to the Enterprises' achievement of their affordable housing mission. FHFA expects that Fannie Mae and Freddie Mac will continue to develop and market such products to fulfill that mission in the future, consistent with safe and sound management of credit risk and maintenance of adequate capital.Q.5. Much has been said about the GSEs' affordable housing mission. Specifically, their mission includes providing ``ongoing assistance to the secondary market for residential mortgages (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing.'' (12 Sec. U.S.C. 1716 and 12 U.S.C. Sec. 1451) The statute specifically recognizes the need to provide affordable housing for low- and moderate-income families. It seems to me that the Affordable Housing Fund and the Capital Magnet Fund will help ensure that the enterprises fulfill this mission. Do you agree? Why or why not?A.5. Section 1337 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended, requires each Enterprise to set aside an amount equal to 4.2 basis points for each dollar of the unpaid principal balance of its total new business purchases as funding for the Housing Trust Fund and Capital Magnet Fund. Each Enterprise's contributions to those funds will further its mission of supporting affordable housing. Section 1337 also authorizes FHFA to suspend the contributions on a temporary basis. After reviewing the Enterprises' 3Q 2008 financial results, FHFA exercised that authority on November 13, 2008, by directing each Enterprise, until further notice, not to set aside or allocate funds for the contributions.Q.6. Director Lockhart, an article in the September 8, 2008 Wall Street Journal stated as follows: ``At both Fannie and Freddie, so-called Alt-A loans, a category between prime and subprime, amounted for roughly 50% of credit losses in the second quarter, even though such loans accounted for only about 10% of the companies' business. Alt-A mortgages include loans made with less than full documentation of borrowers' income or assets.'' Is it true that a disproportionate share of Fannie and Freddie's credit losses are related to mortgage loans that were made without anyone checking the borrower's income? If so, do you think it would be prudent, especially now that the American taxpayer is responsible for insuring loans held by Fannie and Freddie, for the FHFA to require that Fannie and Freddie purchase only those mortgage loans for which income verification has been performed?A.6. A disproportionate share of each Enterprise's credit losses have been on Alternative-A (Alt A) single-family mortgages, which are loans made to borrowers who generally have limited verification of income or assets or no employer. Fannie Mae and Freddie have greatly curtailed their purchases of Alt-A and other low documentation loans in 2008. Beginning in 2009, neither Enterprise will purchase any such mortgages on a flow basis (where loans are delivered pursuant to pre-negotiated contracts and pricing). Acquisitions of pools of such loans on a negotiated basis will occur only after adequate due diligence and with appropriate pricing.Q.7. As I understand it, part of the strategy of the entire mortgage lending crisis is that it would have been so simple to verify consumers' incomes. In her April 6, 2008, New York Times column, Gretchen Morgenson wrote about the IRS 4506-T form, which is a request for tax transcripts, and how lenders could have used that form to avoid a considerable part of the subprime mortgage mess. According to Morgenson's sources, approximately 90 percent of borrowers signed the form, but lenders used the form to obtain tax transcripts only 3 to 5 percent of the time--and usually after the loan had closed. Tax transcripts are prepared by the IRS with data contained in tax returns, and are therefore unlikely to contain exaggerated amounts of income. Given that the 4506-T process is cheap and efficient, do you think IRS tax transcripts should be utilized to protect the GSEs and therefore the American taxpayer from bearing the losses for inappropriate mortgages? Another reason for requiring tax transcripts is that they provide an easy means for identifying fraud. Section 1379 E of the Housing and Economic Recovery Act of 2008 contains the following report requirement:The Director shall require a regulated entity to submit to the Director a timely report upon discovery by the regulated entity that it has purchased or sold a fraudulent loan or financial instrument, or suspects a possible fraud relating to the purchase or sale of any loan or financial instrument. The Director shall require each regulated entity to establish and maintain procedures designed to discover any such transactions.A.7. The income verification processes at Fannie Mae and Freddie Mac have been subject to increased scrutiny by FHFA and these processes have tightened considerably. Working with FHFA, the Enterprises have explored the use of a variety of tools, including IRS forms 4506 and 4506-T, to better verify and document borrower income. Considering the pros and cons of those various approaches, the Enterprises have decided to reduce significantly their purchases of Alt-A mortgages and other lower documentation loans in 2009 and beyond. Given the volume of loans Fannie Mae and Freddie Mac guarantee, it is not operationally feasible for them to individually review every loan; instead, they rely on lenders to verify borrower income and assets and other necessary information. The lenders represent and warrant that mortgages are eligible for Enterprise purchase; if an Enterprise identifies a misrepresentation, it requires the lender to repurchase the questionable loan. Both Fannie Mae and Freddie Mac now require lenders to verify borrower income, have increased their quality control reviews, and are issuing repurchase requests in cases where nonconforming loans are identified. Such repurchases discourage poor underwriting practices, including the use of unverified income to establish borrower eligibility.Q.8. The FDIC's summer 2007 issue of Supervisory Insights cites an April 2006 Mortgage Asset Research Institute report for the fact that ``90 percent of stated incomes [on mortgage loan application] were exaggerated by 5 percent or more, and 60 percent of stated incomes were inflated by more than 50 percent.'' Given these statistics, do you plan to institute, as part of your anti-fraud program, a rule requiring Fannie and Freddie to purchase, re-sell, or otherwise back only loans for which income verification has been executed and what method will you recommend for verification?A.8. Fannie Mae and Freddie Mac are subject to a mortgage fraud reporting regulation promulgated by the Office of Federal Housing Enterprise Oversight (OFHEO), one of the predecessor agencies to FHFA, as set forth in Title 12, Chapter 17, Part 1731 of the Code of Federal Regulations (CFR). That regulation requires each Enterprise to establish adequate and efficient internal controls and procedures and an operational training program to assure an effective system to detect and report mortgage fraud or possible mortgage fraud. The regulation defines mortgage fraud broadly in order to give the Enterprises the flexibility to adapt their internal controls and procedures to fraudulent practices that may emerge over time within the industry. FHFA's ongoing examinations include evaluations of the extent to which the internal policies, procedures, and training programs of the Enterprises minimize risks from mortgage fraud and mortgage fraud or possible mortgage fraud is consistently reported to FHFA. Fannie Mae and Freddie Mac have also increased quality control reviews to identify cases of exaggerated income. The Enterprises are actively requiring lenders to repurchase such loans. As mentioned in the previous answer, working with FHFA the Enterprises have decided to significantly reduce the use of stated income going forward. Any change to that standard will also require a safety-and-soundness review by FHFA.Q.9. The 4506-T process for IRS tax transcripts has a proven track recorded and is currently being utilized by the FDIC in their efforts to modify loans as the conservator for IndyMac. In Housing and Economic Recovery Act of 2008, Congress enacted a requirement pursuant to the HOPE for Homeowners Program that mortgagors' income be checked via tax transcripts or tax returns. In the Bankruptcy Reform Act of 2005, Congress provided debtors the option of producing a transcript of their tax returns via a 4506-T form in lieu of providing their actual tax returns to the court. This was to provide consumers additional privacy protections as well as speed of service. And, as Housing and Urban Development Secretary Preston well knows because he used to be the Administration of the Small Business Administration, the SBA requires a 4506-T form for its loan applications. Given that this process has been adopted and recognized so pervasively, do you see any reason that Fannie and Freddie should not require its use for the loans they purchase, re-sell, or otherwise deal with?A.9. As indicated above, Fannie Mae and Freddie Mac have decided to reduce significantly the use of stated income loans going forward. The Enterprises give lenders several options for verifying income, including using tax records for self-employed individuals. Enterprise lenders use forms 4506 and 4506-T to obtain borrower permission to request tax transcripts from the IRS." FOMC20080310confcall--77 75,MR. EVANS.," Thank you, Mr. Chairman. I support the extension of the swap and the term securities lending facility of up to the $200 billion amount that you're talking about. This can improve market functioning, as I understand the discussion; and it targets action to markets with major liquidity shortfalls, so I think that it is effectively targeting policy to the right place. It has some risks definitely, but it is important to do something innovative like this. I hope that, after these actions, market conditions might improve somewhat so that ultimately fewer adjustments in the funds rate might be called for. If so, then it's possible that the inflation risks that come with those adjustments might be more limited. That's not obviously true because the stance of policy depends on overall accommodation, including in financial markets, but that could be the case. If this works, as you were alluding to, we will get a lot of information from the auctions and the market conditions themselves. Removing this might be a lot easier than actually removing the funds rate accommodation that we talked about as being so important. So targeting this could have another beneficial effect on policy. I would guess that we would review or at least have some assessment of how the policy is working at each of the upcoming FOMC meetings, and that would be a natural time for the Committee to talk about that further. Thank you. " CHRG-110hhrg41184--23 Mrs. Biggert," My concern is always that sometimes what we do would restore credit, or make it impossible for consumers to have the credit if it is limited. So it would make all consumers, not just the ones who are having the credit problems, have to take responsibility for the payments in that effect would restore credit. Do you think the things that you are doing will have any effect on that? " FOMC20080310confcall--67 65,MR. KOHN.," Thank you, Mr. Chairman. I thought I would begin, if it is okay with you, Mr. Chairman, with talking a bit about what I heard in Basel this weekend. I just got back this afternoon from Basel. I think it is fair to say that Bill's description of what is going on in U.S. financial markets is going on much more broadly. Liquidity has dried up in London and other European markets in particular, but elsewhere as well. There is really no price discovery. There is aggressive deleveraging and a flight to safety and soundness. Spreads have widened everywhere. It is true that the EURIBOR�OIS spreads haven't widened very much in the one-month and three-month areas, unless something happened today. But the people from the ECB in Europe reported that they had widened beyond three months, suggesting that people expect this crisis to go on for quite a while. Even in European government bond markets, spreads have widened among different governments that are part of the ECB for the first time since the ECB was founded, reflecting probably liquidity rather than differences in perceived credit risk. Prices were perceived in European markets as well as in U.S. markets to be well out of alignment with any plausible path for economies. That is, the risk spreads were way out of whack with anything that might possibly happen to the economy. There was no price discovery. The prices that were out there were just being driven by fear. Liquidity and solvency were becoming intertwined. The dysfunction in the securities markets and the banking sector were intertwined, and there was just a very vicious spiral going on in many financial markets. ""Dysfunctional"" was the word that a lot of people used to describe their home markets. Even in the emerging market economies, which so far had been relatively ""decoupled""--in the current vogue phrase-- from the industrial economies, there at least the financial markets were becoming coupled to our markets. One emerging market economist-- this is in my CGFS, my global financial system group--reported that locally owned banks in his market were refusing to advance funds through their New York affiliates and their London affiliates to U.S. and European banks. I think I will pause there for the irony to sink in for a second. Those economies that had multinational banks operating in them said that the multinational banks with headquarters in Europe or the United States were definitely selling assets in emerging market economies, not only their portfolios in order to raise funds and hoard liquidity but also subsidiaries were being shopped around in order to conserve their capital. It was broadly viewed that way by everybody, and my global financial system group probably has 35 countries--I don't know the exact number, but every industrialized country and a half a dozen emerging-market economies are represented. When I summarized the meeting just as I did for you and I asked if anyone disagreed with that summary, no hands went up. In that context, the G-10 governors were very concerned about what was going on and about the turn that financial markets had taken over the last couple of months, but especially over the past week. Any number of them said that they had been getting calls on Thursday and Friday from lots of market participants reporting the same type of dynamic that I was just describing to you and being very, very worried. In that context, they suggested--it didn't require any urging by me, I can assure you--that a coordinated announcement such as was undertaken in December would be an appropriate step to take. In addition to the swap actions, the United Kingdom and Canada are planning special auctions in their term funding markets much as they did in December, a similar combination. That will be announced tomorrow in conjunction with our stuff. Let me go on to the TSLF and the swap lines. I support these steps, but I agree with the thrust of the questions. This is not an easy decision. It hasn't been easy for me in any regard. I think in many respects this is a logical next step. We are broadening the collateral. We're expanding securities lending. We're lengthening terms. We're being more aggressive in the term funding markets. We're holding auctions. This is an extension of what we've been doing all along in response to this crisis, and this is just the next step. Other central banks have been doing exactly the same thing, reaching out to counterparties, taking more collateral, and doing more at longer maturities. As you pointed out, Mr. Chairman, one very critical difference between us and the other central banks is that they are dealing with universal banks, so they don't have this division between investment banks and commercial banks in the United Kingdom and Switzerland and in Europe. When they do an open market operation, it's with the investment banks as well as the commercial banks because they are one and the same thing. I think this facility is aimed at the critical piece of the market, the mortgage markets. This is where the problems are most acute and from where they are radiating out into the rest of the market, where the liquidity, price, and solvency interactions are most intense in this downward spiral that Bill described. As Bill and Debby noted, this swap, which can be expanded rapidly, is a very efficient way to try to address this problem, and we don't present the Desk with the issues of absorbing the reserves. But I also acknowledge, as many of you pointed out, that we are crossing a line because of the combination of the collateral and counterparty. It is not so much the asset class--that's not the line we're crossing because we already crossed that line at the discount window. We've taken many classes of assets at the discount window for a long time. The line we're crossing is the combination of the collateral and the counterparty. That's why this has to be a combination of sections 14 and 13 of the act. We are setting a precedent of a sort. I mean, I think we can step back when markets improve, but it is a precedent. There are moral hazards. There are risks. There are reputational risks. I agree with all of those things, and as Chairman Bernanke can tell you, I was resistant to this idea when it was raised a little while ago. But I have changed my mind, and I have changed my mind for a variety of reasons. The first and most important of them is the downward spiral that we're in. I had changed my mind before I went to Europe, but certainly hearing the people in Europe describe the same thing happening on a global basis just reinforced it. That is the most important thing that has happened. We are in dysfunctional markets, and we have to try what we can to help them along. I think there are sensible steps here to limit the costs. The degree that the safety net is being extended is small, but the perception that it is being extended is there. I think we've limited it as best we can. If I thought that price discovery was occurring in these markets, I would be hesitant to do anything that might interfere with it. But there isn't any real price discovery happening. So I don't think this is a case that, if we could only get out of the way, the markets would find their prices, and then the prices would be low enough, and people would step in, and price and liquidity would be restored. That's not what's happening. The markets just aren't operating. There are no guarantees that this will work. We're not addressing the solvency issues that are to a certain extent at the heart of this. But I do think liquidity and solvency are interacting in a particularly difficult and vicious way right now. To the extent that we have even a chance of breaking that spiral by intervening on the liquidity side--which is what the central banks are here for--and can help at least stabilize the situation, it may encourage the dealers to make markets if they know that we're behind there in terms of the AAA mortgage-backed securities tranche as well as the agencies and the agency mortgage-backed securities. I think it is well worth taking the chance in the current situation. One of the members of the CGFS said toward the end of our meeting on Saturday that ""sometimes it's time to think the unthinkable,"" and I think that time is here for us right now, Mr. Chairman. Thank you. " CHRG-111shrg56415--80 PREPARED STATEMENT OF SHEILA C. BAIR Chairman, Federal Deposit Insurance Corporation October 14, 2009 Chairman Johnson, Ranking Member Crapo and members of the Subcommittee, I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) regarding the condition of FDIC-insured institutions and the deposit insurance fund (DIF). While challenges remain, evidence is building that financial markets are stabilizing and the American economy is starting to grow again. As promising as these developments are, the fact is that bank performance typically lags behind economic recovery and this cycle is no exception. Regardless of whatever challenges still lie ahead, the FDIC will continue protecting insured depositors as we have for over 75 years. The FDIC released its comprehensive summary of second quarter 2009 financial results for all FDIC-insured institutions on August 27. The FDIC's Quarterly Banking Profile provided evidence that the difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues to be reflected in the industry's bottom line. As a result, the number of problem institutions increased significantly during the quarter. We expect the numbers of problem institutions to increase and bank failures to remain high for the next several quarters. My testimony today will review the financial performance of FDIC-insured institutions and highlight some of the most significant risks that the industry faces. In addition, I will discuss the steps that we are taking through supervisory and resolutions processes to address risks and to reduce costs from failures. Finally, I will summarize the condition of the DIF and the recent steps that we have taken to strengthen the FDIC's cash position.Economy In the wake of the financial crisis of last Fall and the longest and deepest recession since the 1930s, the U.S. economy appears to be growing once again. Through August, the index of leading economic indicators had risen for five consecutive months. Consensus forecasts call for the economy to grow at a rate of 2.4 percent or higher in both the third and fourth quarters. While this relative improvement in economic conditions appears to represent a turning point in the business cycle, the road to full recovery will be a long one that poses additional challenges for FDIC-insured institutions. While we are encouraged by recent indications of the beginnings of an economic recovery, growth may still lag behind historical norms. There are several reasons why the recovery may be less robust than was the case in the past. Most important are the dislocations that have occurred in the balance sheets of the household sector and the financial sector, which will take time to repair. Households have experienced a net loss of over $12 trillion in net worth during the past 7 quarters, which amounts to almost 19 percent of their net worth at the beginning of the period. Not only is the size of this wealth loss unprecedented in our modern history, but it also has been spread widely among households to the extent that it involves declines in home values. By some measures, the average price of a U.S. home has declined by more than 30 percent since mid-2006. Home price declines have left an estimated 16 million mortgage borrowers ``underwater'' and have contributed to an historic rise in the number of foreclosures, which reached almost 1.5 million in just the first half of 2009.\1\--------------------------------------------------------------------------- \1\ Sources: Moody's Economy.com (borrowers ``underwater'') and FDIC estimate based upon Mortgage Bankers Association, National Delinquency Survey, second quarter 2009 (number of foreclosures).--------------------------------------------------------------------------- Household financial distress has been exacerbated by high unemployment. Employers have cut some 7.2 million jobs since the start of the recession, leaving over 15 million people unemployed and pushing even more people out of the official labor force. The unemployment rate now stands at a 26-year high of 9.8 percent, and may go higher, even in an expanding economy, while discouraged workers re-enter the labor force. In response to these disruptions to wealth and income, U.S. households have begun to save more out of current income. The personal savings rate, which had dipped to as low as 1.2 percent in the third quarter of 2005, rose to 4.9 percent as of second quarter 2009 and could go even higher over the next few years as households continue to repair their balance sheets. Other things being equal, this trend is likely to restrain growth in consumer spending, which currently makes up more than 70 percent of net GDP. Financial sector balance sheets also have undergone historic distress in the recent financial crisis and recession. Most notably, we have seen extraordinary government interventions necessary to stabilize several large financial institutions, and now as the credit crisis takes its toll on the real economy, a marked increase in the failure rate of smaller FDIC-insured institutions. Following a 5-year period during which only ten FDIC-insured institutions failed, there were 25 failures in 2008 and another 98 failures so far in 2009. In all, FDIC-insured institutions have set aside just over $338 billion in provisions for loan losses during the past six quarters, an amount that is about four times larger than their provisions during the prior six quarter period. While banks and thrifts are now well along in the process of loss recognition and balance sheet repair, the process will continue well into next year, especially for commercial real estate (CRE). Recent evidence points toward a gradual normalization of credit market conditions amid still-elevated levels of problem loans. We meet today just 1 year after the historic liquidity crisis in global financial markets that prompted an unprecedented response on the part of governments around the world. In part as a result of the Treasury's Troubled Asset Relief Program (TARP), the Federal Reserve's extensive lending programs, and the FDIC's Temporary Liquidity Guarantee Program (TLGP), financial market interest rate spreads have retreated from highs established at the height of the crisis last Fall and activity in interbank lending and corporate bond markets has increased. However, while these programs have played an important role in mitigating the liquidity crisis that emerged at that time, it is important that they be rolled back in a timely manner once financial market activity returns to normal. The FDIC Board recently proposed a plan to phaseout the debt guarantee component of the Temporary Liquidity Guarantee Program (TLGP) on October 31st. This will represent an important step toward putting our financial markets and institutions back on a self-sustaining basis. And even while we seek to end the various programs that were effective in addressing the liquidity crisis, we also recognize that we may need to redirect our efforts to help meet the credit needs of household and small business borrowers. For now, securitization markets for government-guaranteed debt are functioning normally, but private securitization markets remain largely shut down. During the first 7 months of 2009, $1.2 trillion in agency mortgage-backed securities were issued in comparison to just $9 billion in private mortgage-backed securities. Issuance of other types of private asset-backed securities (ABS) also remains weak. ABS issuance totaled only $118 billion during the first 9 months of 2009 in comparison to $136 billion during the first 9 months of 2008 and peak annual issuance of $754 billion in 2006. Significant credit distress persists in the wake of the recession, and has now spread well beyond nonprime mortgages. U.S. mortgage delinquency and foreclosure rates also reached new historic highs in second quarter of 2009 when almost 8 percent of all mortgages were seriously delinquent. In addition, during the same period, foreclosure actions were started on over 1 percent of loans outstanding.\2\ Consumer loan defaults continue to rise, both in number and as a percent of outstanding loans, although the number of new delinquencies now appears to be tapering off. Commercial loan portfolios are also experiencing elevated levels of problem loans which industry analysts suggest will peak in late 2009 or early 2010.--------------------------------------------------------------------------- \2\ Source: Mortgage Bankers Association, National Delinquency Survey, Second Quarter 2009.---------------------------------------------------------------------------Recent Financial Performance of FDIC-Insured Institutions The high level of distressed assets is reflected in the weak financial performance of FDIC-insured institutions. FDIC-insured institutions reported an aggregate net loss of $3.7 billion in second quarter 2009. The loss was primarily due to increased expenses for bad loans, higher noninterest expenses and a one-time loss related to revaluation of assets that were previously reported off-balance sheet. Commercial banks and savings institutions added $67 billion to their reserves against loan losses during the quarter. As the industry has taken loss provisions at a rapid pace, the industry's allowance for loan and lease losses has risen to 2.77 percent of total loans and leases, the highest level for this ratio since at least 1984. However, noncurrent loans have been growing at a faster rate than loan loss reserves, and the industry's coverage ratio (the allowance for loan and lease losses divided by total noncurrent loans) has fallen to its lowest level since the third quarter of 1991.\3\--------------------------------------------------------------------------- \3\ Noncurrent loans are loans 90 or more days past due or in nonaccrual status.--------------------------------------------------------------------------- Insured institutions saw some improvement in net interest margins in the quarter. Funding costs fell more rapidly than asset yields in the current low interest rate environment, and margins improved in the quarter for all size groups. Nevertheless, second quarter interest income was 2.3 percent lower than in the first quarter and 15.9 percent lower than a year ago, as the volume of earning assets fell for the second consecutive quarter. Industry noninterest income fell by 1.8 percent compared to the first quarter. Credit quality worsened in the second quarter by almost all measures. The share of loans and leases that were noncurrent rose to 4.35 percent, the highest it has been since the data were first reported. Increases in noncurrent loans were led by 1-to-4 family residential mortgages, real estate construction and development loans, and loans secured by nonfarm nonresidential real estate loans. However, the rate of increase in noncurrent loans may be slowing, as the second-quarter increase in noncurrent loans was about one-third smaller than the volume of noncurrent loans added in first quarter. The amount of loans past-due 30-89 days was also smaller at the end of the second quarter than in the first quarter. Net charge-off rates rose to record highs in the second quarter, as FDIC-insured institutions continued to recognize losses in the loan portfolios. Other real estate owned (ORE) increased 79.7 percent from a year ago. Many insured institutions have responded to stresses in the economy by raising and conserving capital, some as a result of regulatory reviews. Equity capital increased by $32.5 billion (2.4 percent) in the quarter. Treasury invested a total of $4.4 billion in 117 independent banks and bank and thrift holding companies during the second quarter, and nearly all of these were community banks. This compares to a total of more than $200 billion invested since the program began. Average regulatory capital ratios increased in the quarter as well. The leverage capital ratio increased to 8.25 percent, while the average total risk-based capital ratio rose to 13.76 percent. However, while the average ratios increased, fewer than half of all institutions reported increases in their regulatory capital ratios. The nation's nearly 7,500 community banks--those with less than $1 billion in total assets--hold approximately 11 percent of total industry assets. They posted an average return on assets of negative 0.06 percent, which was slightly better than the industry as a whole. As larger banks often have more diverse sources of noninterest income, community banks typically get a much greater share of their operating income from net interest income. In general, community banks have higher capital ratios than their larger competitors and are much more reliant on deposits as a source of funding. Average ratios of noncurrent loans and charge-offs are lower for community banks than the industry averages. In part, this illustrates the differing loan mix between the two groups. The larger banks' loan performance reflects record high loss rates on credit card loans and record delinquencies on mortgage loans. Community banks are important sources of credit for the nation's small businesses and small farmers. As of June 30, community banks held 38 percent of the industry's small business and small farm loans.\4\ However, the greatest exposures faced by community banks may relate to construction loans and other CRE loans. These loans made up over 43 percent of community bank portfolios, and the average ratio of CRE loans to total capital was above 280 percent.--------------------------------------------------------------------------- \4\ Defined as commercial and industrial loans or commercial real estate loans under $1 million or farm loans less than $500,000.--------------------------------------------------------------------------- As insured institutions work through their troubled assets, the list of ``problem institutions''--those rated CAMELS 4 or 5--will grow. Over a hundred institutions were added to the FDIC's ``problem list'' in the second quarter. The combined assets of the 416 banks and thrifts on the problem list now total almost $300 billion. However, the number of problem institutions is still well below the more than 1,400 identified in 1991, during the last banking crisis on both a nominal and a percentage basis. Institutions on the problem list are monitored closely, and most do not fail. Still, the rising number of problem institutions and the high number of failures reflect the challenges that FDIC-insured institutions continue to face.Risks to FDIC-Insured Institutions Troubled loans at FDIC-insured institutions have been concentrated thus far in three main areas--residential mortgage loans, construction loans, and credit cards. The credit quality problems in 1-to-4 family mortgage loans and the coincident declines in U.S. home prices are well known to this Committee. Net chargeoffs of 1- to 4-famly mortgages and home equity lines of credit by FDIC-insured institutions over the past 2 years have totaled more than $65 billion. Declining home prices have also impacted construction loan portfolios, on which many small and mid-sized banks heavily depend. There has been a tenfold increase in the ratio of noncurrent construction loans since mid-year 2007, and this ratio now stands at a near-record 13.5 percent. Net charge-offs for construction loans over the past 2 years have totaled about $32 billion, and almost 40 percent of these were for one-to-four family construction. With the longest and deepest recession since the 1930s has come a new round of credit problems in consumer and commercial loans. The net charge-off rate for credit card loans on bank portfolios rose to record-high 9.95 percent in the second quarter. While stronger underwriting standards and deleveraging by households should eventually help bring loss rates down, ongoing labor market distress threatens to keep loss rates elevated for an extended period. By contrast, loans to businesses, i.e., commercial and industrial (C&I) loans, have performed reasonably well given the severity of the recession in part because corporate balance sheets were comparatively strong coming into the recession. The noncurrent loan ratio of 2.79 percent for C&I loans stands more than four times higher than the record low seen in 2007, but remains still well below the record high of 5.14 percent in 1987. The most prominent area of risk for rising credit losses at FDIC-insured institutions during the next several quarters is in CRE lending. While financing vehicles such as commercial mortgage-backed securities (CMBS) have emerged as significant CRE funding sources in recent years, FDIC-insured institutions still hold the largest share of commercial mortgage debt outstanding, and their exposure to CRE loans stands at an historic high. As of June, CRE loans backed by nonfarm, nonresidential properties totaled almost $1.1 trillion, or 14.2 percent of total loans and leases. The deep recession, in combination with ongoing credit market disruptions for market-based CRE financing, has made this a particularly challenging environment for commercial real estate. The loss of more than 7 million jobs since the onset of the recession has reduced demand for office space and other CRE property types, leading to deterioration in fundamental factors such as rental rates and vacancy rates. Amid weak fundamentals, investors have been re-evaluating their required rate of return on commercial properties, leading to a sharp rise in ``cap rates'' and lower market valuations for commercial properties. Finally, the virtual shutdown of CMBS issuance in the wake of last year's financial crisis has made financing harder to obtain. Large volumes of CRE loans are scheduled to roll over in coming quarters, and falling property prices will make it more difficult for some borrowers to renew their financing. Outside of construction portfolios, losses on loans backed by CRE properties have been modest to this point. Net charge-offs on loans backed by nonfarm, nonresidential properties have been just $6.2 billion over the past 2 years. Over this period, however, the noncurrent loan ratio in this category has quadrupled, and we expect it to rise further as more CRE loans come due over the next few years. The ultimate scale of losses in the CRE loan portfolio will very much depend on the pace of recovery in the U.S. economy and financial markets during that time.FDIC Response to Industry Risks and ChallengesSupervisory Response to Problems in Banking Industry The FDIC has maintained a balanced supervisory approach that focuses on vigilant oversight but remains sensitive to the economic and real estate market conditions. Deteriorating credit quality has caused a reduction in earnings and capital at a number of institutions we supervise which has resulted in a rise in problem banks and the increased issuance of corrective programs. We have been strongly advocating increased capital and loan loss allowance levels to cushion the impact of rising non-performing assets. Appropriate allowance levels are a fundamental tenet of sound banking, and we expect that banks will add to their loss reserves as credit conditions warrant--and in accordance with generally accepted accounting principles. We have also been emphasizing the importance of a strong workout infrastructure in the current environment. Given the rising level of non-performing assets, and difficulties in refinancing loans coming due because of decreased collateral values and lack of a securitization market, banks need to have the right resources in place to restructure weakened credit relationships and dispose of other real estate holdings in a timely, orderly fashion. We have been using a combination of offsite monitoring and onsite examination work to keep abreast of emerging issues at FDIC-supervised institutions and are accelerating full-scope examinations when necessary. Bankers understand that FDIC examiners will perform a thorough, yet balanced asset review during our examinations, with a particular focus on concentrations of credit risk. Over the past several years, we have emphasized the risks in real estate lending through examination and industry guidance, training, and targeted analysis and supervisory activities. Our efforts have focused on underwriting, loan administration, concentrations, portfolio management and stress testing, proper accounting, and the use of interest reserves. CRE loans and construction and development loans are a significant examination focus right now and have been for some time. Our examiners in the field have been sampling banks' CRE loan exposures during regular exams as well as special visitations and ensuring that credit grading systems, loan policies, and risk management processes have kept pace with market conditions. We have been scrutinizing for some time construction and development lending relationships that are supported by interest reserves to ensure that they are prudently administrated and accurately portray the borrower's repayment capacity. In 2008, we issued guidance and produced a journal article on the use of interest reserves,\5\ as well as internal review procedures for examiners.--------------------------------------------------------------------------- \5\ FDIC, Supervisory Insights, http://www.fdic.gov/regulations/examinations/supervisory/insights/sisum08/article01_Primer.html.--------------------------------------------------------------------------- We strive to learn from those instances where the bank's failure led to a material loss to the DIF, and we have made revisions to our examination procedures when warranted. This self-assessment process is intended to make our procedures more forward-looking, timely and risk-focused. In addition, due to increased demands on examination staff, we have been working diligently to hire additional examiners since 2007. During 2009, we hired 440 mid career employees with financial services skills as examiners and almost another 200 examiner trainees. We are also conducting training to reinforce important skills that are relevant in today's rapidly changing environment. The FDIC continues to have a well-trained and capable supervisory workforce that provides vigilant oversight of state nonmember institutions.Measures to Ensure Examination Programs Don't Interfere with Credit Availability Large and small businesses are contending with extremely challenging economic conditions which have been exacerbated by turmoil in the credit markets over the past 18 months. These conditions, coupled with a more risk-averse posture by lenders, have diminished the availability of credit. We have heard concerns expressed by Members of Congress and industry representatives that banking regulators are somehow instructing banks to curtail lending, making it more difficult for consumers and businesses to obtain credit or roll over otherwise performing loans. This is not the case. The FDIC provides banks with considerable flexibility in dealing with customer relationships and managing loan portfolios. I can assure you that we do not instruct banks to curtail prudently managed lending activities, restrict lines of credit to strong borrowers, or require appraisals on performing loans unless an advance of new funds is being contemplated. It has also been suggested that regulators are expecting banks to shut off lines of credit or not roll-over maturing loans because of depreciating collateral values. To be clear, the FDIC focuses on borrowers' repayment sources, particularly their cash-flow, as a means of paying off loans. Collateral is a secondary source of repayment and should not be the primary determinant in extending or refinancing loans. Accordingly, we have not encouraged banks to close down credit lines or deny a refinance request solely because of weakened collateral value. The FDIC has been vocal in its support of bank lending to small businesses in a variety of industry forums and in the interagency statement on making loans to creditworthy borrowers that was issued last November. I would like to emphasize that the FDIC wants banks to make prudent small business loans as they are an engine of growth in our economy and can help to create jobs at this critical juncture. In addition, the Federal banking agencies will soon issue guidance on CRE loan workouts. The agencies recognize that lenders and borrowers face challenging credit conditions due to the economic downturn, and are frequently dealing with diminished cash-flows and depreciating collateral values. Prudent loan workouts are often in the best interest of financial institutions and borrowers, particularly during difficult economic circumstances and constrained credit availability. This guidance reflects that reality, and supports prudent and pragmatic credit and business decisionmaking within the framework of financial accuracy, transparency, and timely loss recognition.Innovative resolution structures The FDIC has made several changes to its resolution strategies in response to this crisis, and we will continue to re-evaluate our methods going forward. The most important change is an increased emphasis on partnership arrangements. The FDIC and RTC used partnership arrangements in the past--specifically loss sharing and structured transactions. In the early 1990s, the FDIC introduced and used loss sharing. During the same time period, the RTC introduced and used structured transactions as a significant part of their asset sales strategy. As in the past, the FDIC has begun using these types of structures in order to lower resolution costs and simplify the FDIC's resolution workload. Also, the loss share agreements reduce the FDIC's liquidity needs, further enhancing the FDIC's ability to meet the statutory least cost test requirement. The loss share agreements enable banks to acquire an entire failed bank franchise without taking on too much risk, while the structured transactions allow the FDIC to market and sell assets to both banks and non-banks without undertaking the tasks and responsibilities of managing those assets. Both types of agreements are partnerships where the private sector partner manages the assets and the FDIC monitors the partner. An important characteristic of these agreements is the alignment of interests: both parties benefit financially when the value of the assets is maximized. For the most part, after the end of the savings and loan and banking crisis of the late 1980s and early 1990s, the FDIC shifted away from these types of agreements to more traditional methods since the affected asset markets became stronger and more liquid. The main reason why we now are returning to these methods is that in the past several months investor interest has been low and asset values have been uncertain. If we tried to sell the assets of failed banks into today's markets, the prices would likely be well below their intrinsic value--that is, their value if they were held and actively managed until markets recover. The partnerships allow the FDIC to sell the assets today but still benefit from future market improvements. During 2009, the FDIC has used loss share for 58 out of 98 resolutions. We estimate that the cost savings have been substantial: the estimated loss rate for loss share failures averaged 25 percent; for all other transactions, it was 38 percent. Through September 30, 2009, the FDIC has entered into seven structured transactions, with about $8 billion in assets. To address the unique nature of today's crisis, we have made several changes to the earlier agreements. The earlier loss share agreements covered only commercial assets. We have updated the agreements to include single family assets and to require the application of a systematic loan modification program for troubled mortgage loans. We strongly encourage our loss share partners to adopt the Administration's Home Affordable Modification Program (HAMP) for managing single family assets. If they do not adopt the HAMP, we require them to use the FDIC loan modification program which was the model for the HAMP modification protocol. Both are designed to ensure that acquirers offer sustainable and affordable loan modifications to troubled homeowners whenever it is cost-effective. This serves to lower costs and minimize foreclosures. We have also encouraged our loss share partners to deploy forbearance programs when homeowners struggle with mortgage payments due to life events (unemployment, illness, divorce, etc.). We also invite our loss share partners to propose other innovative strategies that will help keep homeowners in their homes and reduce the FDIC's costs. In addition, the FDIC has explored funding changes to our structured transactions to make them more appealing in today's environment. To attract more bidders and hopefully higher pricing, the FDIC has offered various forms of leverage. In recent transactions where the leverage was provided to the investors, the highest bids with the leverage option substantially improved the overall economics of the transactions. The overall feedback on the structure from both investors and market participants was very positive.The Condition of the Deposit Insurance FundCurrent Conditions and Projections As of June 30, 2009, the balance (or net worth) of the DIF (the fund) was approximately $10 billion. The fund reserve ratio--the fund balance divided by estimated insured deposits in the banking system--was 0.22 percent. In contrast, on December 31, 2007, the fund balance was almost $52 billion and the reserve ratio was 1.22 percent. Losses from institution failures have caused much of the decline in the fund balance, but increases in the contingent loss reserve--the amount set aside for losses expected during the next 12 months--has contributed significantly to the decline. The contingent loss reserve on June 30 was approximately $32 billion. The FDIC estimates that as of September 30, 2009, both the fund balance and the reserve ratio were negative after reserving for projected losses over the next 12 months, though our cash position remained positive. This is not the first time that a fund balance has been negative. The FDIC reported a negative fund balance during the last banking crisis in the late 1980s and early 1990s.\6\ Because the FDIC has many potential sources of cash, a negative fund balance does not affect the FDIC's ability to protect insured depositors or promptly resolve failed institutions.--------------------------------------------------------------------------- \6\ The FDIC reported a negative fund balance as of December 31, 1991 of approximately -$7.0 billion due to setting aside a large ($16.3 billion) reserve for future failures. The fund remained negative for five quarters, until March 31, 1993, when the fund balance was approximately $1.2 billion.--------------------------------------------------------------------------- The negative fund balance reflects, in part, an increase in provisioning for anticipated failures. The FDIC projects that, over the period 2009 through 2013, the fund could incur approximately $100 billion in failure costs. The FDIC projects that most of these costs will occur in 2009 and 2010. In fact, well over half of this amount will already be reflected in the September 2009 fund balance. Assessment revenue is projected to be about $63 billion over this 5-year period, which exceeds the remaining loss amount. The problem we are facing is one of timing. Losses are occurring in the near term and revenue is spread out into future years. At present, cash and marketable securities available to resolve failed institutions remain positive, although they have also declined. At the beginning of the current banking crisis, in June 2008, total assets held by the fund were approximately $55 billion, and consisted almost entirely of cash and marketable securities (i.e., liquid assets). As the crisis has unfolded, the liquid assets of the fund have been expended to protect depositors of failed institutions and have been exchanged for less liquid claims against the assets of failed institutions. As of June 30, 2009, while total assets of the fund had increased to almost $65 billion, cash and marketable securities had fallen to about $22 billion. The pace of resolutions continues to put downward pressure on cash balances. While the less liquid assets in the fund have value that will eventually be converted to cash when sold, the FDIC's immediate need is for more liquid assets to fund near-term failures. If the FDIC took no action under its existing authority to increase its liquidity, the FDIC projects that its liquidity needs would exceed its liquid assets next year.The FDIC's Response The FDIC has taken several steps to ensure that the fund reserve ratio returns to its statutorily mandated minimum level of 1.15 percent within the time prescribed by Congress and that it has sufficient cash to promptly resolve failing institutions. For the first quarter of 2009, the FDIC raised rates by 7 basis points. The FDIC also imposed a special assessment as of June 30, 2009 of 5 basis points of each institution's assets minus Tier 1 capital, with a cap of 10 basis points of an institution's regular assessment base. On September 22, the FDIC again took action to increase assessment rates--the board decided that effective January 1, 2011, rates will uniformly increase by 3 basis points. The FDIC projects that bank and thrift failures will peak in 2009 and 2010 and that industry earnings will have recovered sufficiently by 2011 to absorb a 3 basis point increase in deposit insurance assessments. We project that these steps should return the fund to a positive balance in 2012 and the reserve ratio to 1.15 percent by the first quarter of 2017. While the final rule imposing the special assessment in June permitted the FDIC to impose additional special assessments of the same size this year without further notice and comment rulemaking, the FDIC decided not to impose any additional special assessments this year. Any additional special assessment would impose a burden on an industry that is struggling to achieve positive earnings overall. In general, an assessment system that charges institutions less when credit is restricted and more when it is not is more conducive to economic stability and sustained growth than a system that does the opposite. To meet the FDIC's liquidity needs, on September 29 the FDIC authorized publication of a Notice of Proposed Rulemaking (NPR) to require insured depository institutions to prepay about 3 years of their estimated risk-based assessments. The FDIC estimates that prepayment would bring in approximately $45 billion in cash. Unlike a special assessment, prepaid assessments would not immediately affect the DIF balance or depository institutions' earnings. An institution would record the entire amount of its prepaid assessment as a prepaid expense (asset) as of December 30, 2009. As of December 31, 2009, and each quarter thereafter, the institution would record an expense (charge to earnings) for its regular quarterly assessment for the quarter and an offsetting credit to the prepaid assessment until the asset is exhausted. Once the asset is exhausted, the institution would record an expense and an accrued expense payable each quarter for its regular assessment, which would be paid in arrears to the FDIC at the end of the following quarter. On the FDIC side, prepaid assessments would have no effect on the DIF balance, but would provide us with the cash needed for future resolutions. The proposed rule would allow the FDIC to exercise its discretion as supervisor and insurer to exempt an institution from the prepayment requirement if the FDIC determines that the prepayment would adversely affect the safety and soundness of the institution. The FDIC believes that using prepaid assessments as a means of collecting enough cash to meet upcoming liquidity needs to fund future resolutions has significant advantages compared to imposing additional or higher special assessments. Additional or higher special assessments could severely reduce industry earnings and capital at a time when the industry is under stress. Prepayment would not materially impair the capital or earnings of insured institutions. In addition, the FDIC believes that most of the prepaid assessment would be drawn from available cash and excess reserves, which should not significantly affect depository institutions' current lending activities. As of June 30, FDIC-insured institutions held more than $1.3 trillion in liquid balances, or 22 percent more than they did a year ago.\7\--------------------------------------------------------------------------- \7\ Liquid balances include balances due from Federal Reserve Banks, depository institutions and others, Federal funds sold, and securities purchased under agreements to resell.--------------------------------------------------------------------------- In the FDIC's view, requiring that institutions prepay assessments is also preferable to borrowing from the U.S. Treasury. Prepayment of assessments ensures that the deposit insurance system remains directly industry-funded and it preserves Treasury borrowing for emergency situations. Additionally, the FDIC believes that, unlike borrowing from the Treasury or the FFB, requiring prepaid assessments would not count toward the public debt limit. Finally, collecting prepaid assessments would be the least costly option to the fund for raising liquidity as there would be no interest cost. However, the FDIC is seeking comment on these and other options in the NPR. The FDIC's proposal requiring prepayment of assessments is really about how and when the industry fulfills its obligation to the insurance fund. It is not about whether insured deposits are safe or whether the FDIC will be able to promptly resolve failing institutions. Deposits remain safe; the FDIC has ample resources available to promptly resolve failing institutions. We thank the Congress for raising our borrowing limit, which was important from a public confidence standpoint and essential to assure that the FDIC is prepared for all contingencies in these difficult times.Conclusion FDIC-insured banks and thrifts continue to face many challenges. However, there is no question that the FDIC will continue to ensure the safety and soundness of FDIC-insured financial institutions, and, when necessary, resolve failed financial institutions. Regarding the state of the DIF and the FDIC Board's recent proposal to have banks pay a prepaid assessment, the most important thing for everyone to remember is that the outcome of this proposal is a non-event for insured depositors. Their deposits are safe no matter what the Board decides to do in this matter. Everyone knows that the FDIC has immediate access to a $100 billion credit line at Treasury that can be expanded to $500 billion with the concurrence of the Federal Reserve and the Treasury. We also have authority to borrow additional working capital up to 90 percent of the value of assets we own. The FDIC's commitment to depositors is absolute, and we have more than enough resources at our disposal to make good on that commitment. I would be pleased to answer any questions from the members of the Subcommittee. ______ CHRG-111shrg52619--191 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM MICHAEL E. FRYZELQ.1. Consumer Protection Regulation--Some have advocated that consumer protection and prudential supervision should be divorced, and that a separate consumer protection regulation regime should be created. They state that one source of the financial crisis emanated from the lack of consumer protection in the underwriting of loans in the originate-to-distribute space. What are the merits of maintaining it in the same agency? Alternatively, what is the best argument each of you can make for a new consumer protection agency?A.1. Credit unions occupy a very small space within the originate-to-distribute landscape. Less than 8 percent of the $250 billion in loans originated by credit unions in 2008 were sold in whole to another party. While selling loans has grown within the credit union industry, it remains a small portion of business, with most credit unions choosing to hold their loans in portfolio when possible. Additionally, the abuses of consumers seen in some areas have not manifested themselves within the credit union community. The originate-to-distribute model would seem to create an environment where the loan originator is less concerned about consumer protection and more concerned with volume and fee generation. The lender using this model may focus less on what is best for the borrower, as they will not be the entity retaining the liability should the borrower later default. Maintaining consumer protection with the same regulator who is responsible for prudential supervision adds economies of scale and improves efficiencies for completing the supervision of the institutions. This approach allows one regulator to possess all information and authority regarding the supervision of individual institutions. In the past, NCUA has performed consumer compliance examinations separate from safety and soundness examinations. However, in order to maximize economies of scales and allow examiners to possess all information regarding the institution, the separation of consumer compliance and safety and soundness examinations was discontinued. Some federal and state agencies currently perform those functions as two separate types of examination under one regulator. The oversight of consumer protection could be given to a separate regulatory agency. The agency would likely have broad authority over all financial institutions and affiliated parties. In theory, creating such an agency would allow safety and soundness examiners to focus on those particular risks. For those agencies without consumer compliance examiners, it would create an agency of subject matter experts to help ensure consumer protection laws are adhered to.Q.2. Regulatory Gaps or Omissions--During a recent hearing, the Committee has heard about massive regulatory gaps in the system. These gaps allowed unscrupulous actors like AIG to exploit the lack of regulatory oversight. Some of the counterparties that AIG did business with were institutions under your supervision. Why didn't your risk management oversight of the AIG counterparties trigger further regulatory scrutiny? Was there a flawed assumption that AIG was adequately regulated, and therefore no further scrutiny was necessary? Was there dialogue between the banking regulators and the state insurance regulators? What about the SEC? If the credit default swap contracts at the heart of this problem had been traded on an exchange or cleared through a clearinghouse, with requirement for collateral and margin payments, what additional information would have been available? How would you have used it?A.2. NCUA does not directly or indirectly regulate or oversee the operation of AIG. Therefore, we defer to the other regulatory bodies. Chartering and regulatory restrictions prevent federally chartered credit unions from investing in companies such as AIG. Federally chartered credit unions are generally limited to investing in government issued or guaranteed securities and cannot invest in the diverse range of higher yielding products, including commercial paper and corporate debt securities.Q.3. Liquidity Management--A problem confronting many financial institutions currently experiencing distress is the need to roll-over short-term sources of funding. Essentially these banks are facing a shortage of liquidity. I believe this difficulty is inherent in any system that funds long-term assets, such as mortgages, with short-term funds. Basically the harm from a decline in liquidity is amplified by a bank's level of ``maturity-mismatch.'' I would like to ask each of the witnesses, should regulators try to minimize the level of a bank's maturity-mismatch? And if so, what tools would a bank regulator use to do so?A.3. Funding long-term, fixed-rate loans with short-term funds is a significant concern. The inherent risk in such balance sheet structuring is magnified with the increased probability that the United States may soon enter a period of inflation and rising rates on short-term funding sources. The effects of a rising interest rate environment when most funding sources have no maturity or a maturity of less than one year creates the potential for substantial narrowing of net interest margins moving forward. NCUA recently analyzed how credit union balance sheets have transformed over the last 10 years, especially in the larger institutions. Letter to Credit Unions 08-CU-20, Evaluating Current Risks to Credit Unions, examines the changing balance sheet risk profile. The Letter provides the industry words of caution as well as direction on addressing current risks. NCUA has also issued several other Letters to Credit Unions over the past several years regarding this very issue and has developed additional examiner tools for evaluating liquidity and interest rate risk. While there are various tools the industry uses for measuring interest rate and liquidity risk, the tools involve making many assumptions. The assumptions become more involved as balance sheets become more complex. Each significant assumption needs to be evaluated for reasonableness, with the underlying assumption not necessarily having been tested over time or over all foreseeable scenarios. The grey area in such analysis is significant. In our proposed regulatory changes for corporate credit unions, better matching of maturities of assets and liabilities will be regulated with concentration and sector limits as well as other controls.Q.4. Too-Big-To-Fail--Chairman Bair stated in her written testimony that ``the most important challenge is to find ways to impose greater market discipline on systemically important institutions. The solution must involve, first and foremost, a legal mechanism for the orderly resolution of those institutions similar to that which exists for FDIC-insured banks. In short we need to end too big to fail. I would agree that we need to address the too-big-to-fail issue, both for banks and other financial institutions.'' Could each of you tell us whether putting a new resolution regime in place would address this issue?A.4. While the NCUA continues to recommend maintaining multiple financial regulators and charter options to enable the continued checks and balances such a structure produces, the agency also agrees with the need for establishing a regulatory oversight entity to help mitigate risk to the nation's financial system. Extending the reach of this entity beyond the federally regulated financial institutions may help impose market discipline on systemically important institutions. Care needs to be taken in deciding how to address the too-big-to-fail issue. Overreaching could stifle financial innovation and actually cause more harm than good. At the same time, under reaching could provide inadequate resolution when it is needed most. The statutory construct of federal credit unions limits growth with membership restrictions, so no new initiatives are deemed necessary to address the ``too big to faily7is sue for credit unions. Federally insured credit unions hold $8 13.44 billion in assets, while financial institutions insured by the FDIC hold $13.85 trillion in assets. Federally insured credit unions make up only 5.56 percent of all federally insured assets. \1\ Therefore, the credit union industry as a whole does not pose a systemic risk to the financial industry. However, federally insured credit unions serve a unique role in the financial industry by providing basic and affordable financial services to their members. In order to preserve this role, federally insured credit unions must maintain their independent regulator and insurer.--------------------------------------------------------------------------- \1\ Based on December 31, 2008, financial data.Q.5. How would we be able to convince the market that these systemically important institutions would not be protected by ---------------------------------------------------------------------------taxpayer resources as they had been in the past?A.5. It will be difficult to convince a market accustomed to seeing taxpayer bailouts of systemically important institutions that those institutions will no longer be protected by taxpayer resources. A regulatory oversight entity empowered to resolve institutions deemed systemically important would help impose greater market discipline. Given the recent and historical government intercession, consumers and the marketplace have become accustomed to and grown to expect financial assistance from the government. The greater the expectation for government to use taxpayer resources to resolve institutions the greater the moral hazard becomes. This could cause institutions to take greater levels of risk knowing they will not have to face the consequences.Q.6. Pro-Cyclicality--I have some concerns about the pro-cyclical nature of our present system of accounting and bank capital regulation. Some commentators have endorsed a concept requiring banks to hold more capital when good conditions prevail, and then allow banks to temporarily hold less capital in order not to restrict access to credit during a downturn. Advocates of this system believe that counter cyclical policies could reduce imbalances within financial markets and smooth the credit cycle itself. What do you see as the costs and benefits of adopting a more counter-cyclical system of regulation?A.6. In managing the National Credit Union Share Insurance Fund (NCUSIF), the NCUA Board's Normal Operating Level policy considers the counter-cyclical impact when managing the Fund's equity level. During otherwise stable or prosperous economic periods, the Board may assess a premium, up to the statutory limits, to increase the Fund equity level, in order to avoid the need to charge premiums at the trough of the business cycle. In order to improve this system, NCUA would need the ability to charge premiums, during good times, above the current threshold (an equity level of 1.30). A more robust and flexible risk-based capital requirement for credit unions would improve counter-cyclical impact. Currently, NCUA does not have authority to allow overall capital levels to vary based on swings in the business cycle. Prompt Corrective Action (12 U.S.C. 1790d) establishes statutory minimum levels of capital which are not flexible.Q.7. Do you see any circumstances under which your agencies would take a position on the merits of counter-cyclical regulatory policy?A.7. NCUA will support efforts to improve counter-cyclical regulatory policy. Greater flexibility in the management of the NCUSIF's equity level and improvements in the measurement and retention of capital for credit unions are good starting points.Q.8. G20 Summit and International Coordination--Many foreign officials and analysts have said that they believe the upcoming G20 summit will endorse a set of principles agreed to by both the Financial Stability Forum and the Basel Committee, in addition to other government entities. There have also been calls from some countries to heavily re-regulate the financial sector, pool national sovereignty in key economic areas, and create powerful supranational regulatory institutions. (Examples are national bank resolution regimes, bank capital levels, and deposit insurance.) Your agencies are active participants in these international efforts. What do you anticipate will be the result of the G20 summit? Do you see any examples or areas where supranational regulation of financial services would be effective? How far do you see your agencies pushing for or against such supranational initiatives?A.8. Many news accounts characterize the recent G20 summit as a forum for international cooperation to discuss the condition of the international financial system and to promote international financial stability. NCUA supports these efforts to share information and ideas and to marshal international support for a concerted effort to stabilize the global economy. In comparison to banks, federally insured credit unions are relatively small institutions. Additionally, because of the limited nature of a credit union's field of membership (those individuals a credit union is authorized to serve), U.S. credit unions are almost exclusively domestic institutions with virtually no, or highly limited, international presence. Accordingly, NCUA believes that a supranational regulatory institution would not be an effective tool for credit union regulation. Because of credit unions' small size and unique structure, NCUA believes credit unions need the customized supervisory approach that can only be provided by an agency dedicated to the exclusive regulation of credit unions, and which understands the unique nature of credit union operations. In the broader financial regulatory context, NCUA is hesitant to endorse the creation of powerful supranational regulatory institutions without knowing more about the extent of authority and jurisdiction those regulatory entities would have over U.S. financial institutions. While NCUA supports international cooperation, NCUA believes it is vital to economic and national security to maintain complete U.S. sovereignty over U.S. financial institutions. ------ FOMC20070131meeting--247 245,MR. LACKER.," Yes, indeed. But if you just plot the two for the past year and a half, you see a kind of two-month or three-month echo into the core. You calculate the cross correlations. They were pretty high before 1984; they were low from 1984 to 2001. They’ve been high again since. My reading of the financial press coverage of macroeconomic conditions following the hurricanes in late ’05 is that we saw a sudden burst of references to the macroeconomic conditions of the 1970s. I suspect—it is hard to disprove this one way or another—that rhetoric harkening back to slowing growth and energy prices causing higher inflation induced, in the public’s mind, a sense that, when energy prices surge, growth is going to be lower. You saw the policy path come down in September of ’05, and you’re going to see higher core inflation, and that’s what we saw that fall. To some extent, we tried to speak strongly of our desire to hold inflation down, but in hindsight we left that association in the public’s mind. So I just think this is a conditionality that appears now to have been built into expectations." FOMC20070321meeting--161 159,MR. POOLE.," I think the likely effect of taking the firming language out this afternoon will be as Mike Moskow suggests. But the more important point is how it conditions the market over the period to the next meeting. There I think it’s going to be driven by the flow of incoming data, and I think that’s the more important point." CHRG-111shrg54675--86 PREPARED STATEMENT OF ED TEMPLETON President and Chief Executive Officer, SRP Federal Credit Union, North Augusta, South Carolina, On Behalf of the National Association of Federal Credit Unions July 8, 2009Introduction Good afternoon, Chairman Johnson, Ranking Member Crapo, and Members of the Subcommittee. My name is Ed Templeton and I am testifying today on behalf of the National Association of Federal Credit Unions (NAFCU). I serve as the President and CEO of SRP Federal Credit Union, headquartered in North Augusta, South Carolina. I have been President and CEO of SRP FCU for the last 22 years. SRP FCU is a community credit union serving over 92,000 members in several counties in South Carolina along the Georgia border. Our membership includes Allendale and Barnwell counties which are some of the most rural in South Carolina. They are also some of the poorest, with over 20 percent of the population in Barnwell and over 35 percent of the population in Allendale living below the poverty level. SRP FCU has a strong presence in these counties, with over 20 percent of the adult population in Allendale and over 50 percent of the adult population in Barnwell being members of SRP FCU. I currently serve as the Secretary of NAFCU's Board of Directors. I formerly served on the NAFCU Education Committee and was President of the Columbia Chapter of Credit Unions. I received my BBA from Augusta College, graduated from the Georgia School of Banking and the BAI School of Bank Administration at the University of Wisconsin. NAFCU is the only national organization exclusively representing the interests of the Nation's federally chartered credit unions. NAFCU-member credit unions collectively account for approximately 63.9 percent of the assets of all federally chartered credit unions. NAFCU and the entire credit union community appreciate the opportunity to participate in this discussion regarding how the current economic crisis has impacted America's credit unions serving those in rural communities. Historically, credit unions have served a unique function in the delivery of necessary financial services to Americans. Established by an act of Congress in 1934, the Federal credit union system was created, and has been recognized, as a way to promote thrift and to make financial services available to all Americans, many of whom would otherwise have limited access to financial services. Congress established credit unions as an alternative to banks and to meet a precise public need--a niche that credit unions fill today for nearly 90 million Americans. Every credit union is a cooperative institution organized ``for the purpose of promoting thrift among its members and creating a source of credit for provident or productive purposes.'' (12 USC 1752(1)). While over 75 years have passed since the Federal Credit Union Act (FCUA) was signed into law, two fundamental principles regarding the operation of credit unions remain every bit as important today as in 1934: credit unions remain totally committed to providing their members with efficient, low-cost, personal financial service; and, credit unions continue to emphasize traditional cooperative values such as democracy and volunteerism. Credit unions are not banks. The Nation's approximately 7,800 federally insured credit unions serve a different purpose and have a fundamentally different structure than banks. Credit unions exist solely for the purpose of providing financial services to their members, while banks aim to make a profit for a limited number of shareholders. As owners of cooperative financial institutions united by a common bond, all credit union members have an equal say in the operation of their credit union--``one member, one vote''--regardless of the dollar amount they have on account. These singular rights extend all the way from making basic operating decisions, to electing the board of directors--something unheard of among for-profit, stock-owned banks. Unlike their counterparts at banks and thrifts, Federal credit union directors generally serve without remuneration--a fact epitomizing the true ``volunteer spirit'' permeating the credit union community. Credit unions have grown steadily in membership and assets, but in relative terms, they make up a small portion of the financial services marketplace. Federally insured credit unions have approximately $856.4 billion in assets as of March 2009. By contrast, Federal Deposit Insurance Corporation (FDIC) insured institutions have $13.6 trillion in assets. The average size of a Federal credit union is $97.6 million compared to $1.647 billion for banks. Almost 3,200 credit unions have less than $10 million in assets. The credit union share of total household financial assets is also relatively small, at only 1.5 percent as of March 2009. Size has no bearing on a credit union's structure or adherence to the credit union philosophy of service to members and the community. While credit unions may have grown, their relative size is still small compared with banks. Even the world's largest credit union, with $38.7 billion in assets, is dwarfed by the Nation's biggest banks who hold trillions of dollars in assets. America's credit unions have always remained true to their original mission of ``promoting thrift'' and providing ``a source of credit for provident or productive purposes.'' In fact, Congress acknowledged this point when it adopted the Credit Union Membership Access Act (CUMAA--P.L. 105-219) a decade ago. In the ``findings'' section of that law, Congress declared that, ``The American credit union movement began as a cooperative effort to serve the productive and provident credit needs of individuals of modest means . . . [and it] continue[s] to fulfill this public purpose.'' Credit unions continue to play a very important role in the lives of millions of Americans from all walks of life. As consolidation of the commercial banking sector has progressed, with the resulting depersonalization in the delivery of financial services by banks, the emphasis in consumers' minds has begun to shift not only to services provided but also--more importantly--to quality and cost. Credit unions are second to none in providing their members with quality personal financial service at the lowest possible cost. While the lending practices of many other financial institutions led to the Nation's subprime mortgage debacle, data collected under the Home Mortgage Disclosure Act (HMDA) illustrates the value of credit unions to their communities. The difference between credit unions and banks is highlighted when one examines the 2007 HMDA data for loans to minority applicants with household incomes under $40,000. According to the 2007 HMDA data, banks have a significantly higher percentage of mortgage purchase loans (20.8 percent), charging at least 3 percent higher than the comparable Treasury yield for minority applicants with household income under $40,000. Credit unions, on the other hand, had only 4.4 percent of their loans in that category.Credit Unions in the Current Economic Environment While credit unions have fared better than most financial institutions in these turbulent economic times, many have been impacted, through no fault of their own, by the current economic environment. Many credit unions, including smaller ones, have seen an increase in delinquencies and charge-offs in recent quarters. Some of this impact has been regional, depending on local economic conditions. In particular, the corporate credit union system has felt the biggest impact, and the National Credit Union Administration (NCUA) placed the two largest corporate credit unions, U.S. Central Federal Credit Union and Western Corporate Federal Credit Union, into receivership earlier this year. The passage and enactment of S. 896, The Helping Families Save Their Homes Act of 2009, and the temporary corporate credit union stabilization fund that it created provided important relief to natural-person credit unions in these challenging times. We thank you for work on this matter. It is also widely recognized by leaders on Capitol Hill and in the Administration that credit unions were not cause of the current economic downturn, but we believe we can be an important part of the solution. As credit unions have fared well in the current environment, there are many that have capital available. Surveys of NAFCU member credit unions have shown that many are seeing increased demand for mortgage loans and auto loans as other lenders leave the market. A number of credit unions are also seeing local small businesses, who have lost lines of credit from other lenders, turn to them for the capital they need. Credit unions are helping meet those needs in rural areas. Despite the economic downtown, an analysis of NCUA Form 5300 Call Report data shows that credit unions have seen a growth in the percentage of total amount of credit union farm loans to members for the last nine consecutive quarters during the current recession. Additionally, on examination of 2007 HMDA data (the last year that is available) shows that credit union mortgage loans to American Indians grew at an annual rate of 9.23 percent over the previous year and that credit unions had a higher percentage of approved loans to American Indians (75.31 percent) than other types of financial institutions. The NCUA has been working to assist small credit unions as well. In April, the NCUA Board finalized actions to centralize NCUA's chartering within the Headquarters' Office of Small Credit Union Initiatives (OSCUI), thereby creating a national chartering program to reduce regulatory burden on credit union charter applicants. The revisions delegate OSCUI authority to approve and reject new charters, and require OSCUI's concurrence to revoke new charters. This new process should assist individuals in understanding the process of chartering a new institution and help keep new growth in the credit union industry. Additionally, many smaller credit unions rely on other credit unions for support and to provide effective service to their respective memberships. Throughout the country small credit union roundtables have emerged for credit unions to discuss operational concerns with like institutions. Larger credit unions also serve as partners for smaller institutions, and perform functions ranging from shared branching to back office operations. We at SRP FCU are actually expanding at this time in some of the most rural areas of our field of membership, and we are about to break ground on a new credit union branch in Allendale County.Current Challenges Credit unions are the most highly regulated of all financial institutions, facing restrictions on who they can serve and their ability to raise capital, among a host of other limitations. There are other statutory limitations on credit unions that hamper their ability to serve their members, including those in rural areas. These include: Credit Union Member Business Lending Cap. The Credit Union Membership Access Act (CUMAA) established an arbitrary cap on credit union member business lending of 12.25 percent of assets in 1998. CUMAA also directed the Treasury Department to study the need for such a cap. In 2001, the Treasury Department released its study entitled ``Credit Union Member Business Lending'' in which it concluded that ``credit unions' business lending currently has no effect on the viability and profitability of other insured depository institutions.'' That same study also found that over 50 percent of credit union loans were made to businesses with assets under $100,000, and 45 percent of credit union business loans go to individuals with household incomes of less than $50,000. The current economic crisis has demonstrated the need to have capital available to help our Nation's small businesses, especially in troubling times. Many credit unions have the capital that other lenders do not in this environment, but are hamstrung by such an arbitrary limitation. We are pleased that Senator Schumer has indicated that he plans to introduce legislation to remove this arbitrary cap, and we urge the Subcommittee to support and advance those efforts. Underserved Areas. As the Subcommittee is aware, many rural areas are also underserved. Credit unions play an important role in helping those on whom other financial institutions have turned their backs and left behind. The 1998 Credit Union Membership Access Act (CUMAA) gave the NCUA the authority to allow Federal credit unions to add underserved areas to their field of membership; however, the language was unclear as to what types of charters were permitted to add underserved areas. For an area to be ``underserved,'' CUMAA requires the NCUA Board to determine that a local community, neighborhood or rural district is an ``investment area'' as defined in the Community Development Banking and Financial Institutions Act of 1994, and also that it is ``underserved by other depository institutions.'' 2 U.S.C. 1759(c)(2)(A). NAFCU supports making a necessary clarification to the CUMAA that credit unions are able to add underserved areas to their fields of membership, regardless of charter type. In 2005, the American Bankers Association brought litigation against NCUA, arguing that under the plain language of CUMAA (American Bankers Association, et al., v. NCUA, No. 2:05-cv-000904 (D. Utah, filed Nov. 1, 2006)), only multiple-common-bond credit unions could add underserved areas to their fields of membership. Up to that point, NCUA had permitted all types of credit unions to add underserved areas to their field of membership. Even though there was legislative history supporting the NCUA interpretation, the case settled out of court, and as a result, NCUA modified its rules to prohibit community and single-sponsor Federal credit unions from adding underserved areas to their field of membership. NAFCU and the credit union community believe that addressing this issue through legislation would clear up the ambiguity surrounding the ability of Federal credit unions to add underserved areas to their fields of membership. NCUA's current rules do not address how a rural district should be defined for the purposes of adding underserved areas. Recognizing that there was a need to streamline the process for credit unions in rural areas to add underserved areas to their fields of membership, NCUA proposed an amendment to their Chartering and Field of Membership Manual in 2008. NAFCU provided feedback from many of our rural members during the notice and comment period, and we look forward to Congress clarifying this issue and seeing NCUA continue its work to provide streamlined guidelines.Regulatory Reform While credit unions have generally performed well in the current economic crisis, we remain concerned that well-intentioned efforts at regulatory reform could ultimately have a negative impact on credit unions and their members. As not-for-profit member-owned cooperatives, credit unions are unique institutions in the financial services arena. We believe that the NCUA should remain an independent regulator of credit unions and are pleased to see that the Administration's proposal would maintain the Federal credit union charter and an independent National Credit Union Administration (NCUA). NAFCU does support the creation of a Consumer Financial Protection Agency (CFPA), which would have authority over nonregulated institutions that operate in the financial services marketplace. However, we do not believe such an agency should have authority over regulated federally insured depository institutions, and do not support extending that authority to federally insured credit unions. Giving the CFPA such authority to regulate, examine and supervise credit unions that already are regulated by the NCUA would add an additional regulatory burden and cost. Additionally, it could lead to situations in which institutions regulated by one agency for safety and soundness find their guidance in conflict with their regulator for consumer issues. Such a conflict and burden will surely increase compliance costs to credit unions, leading to diminished services to their members. Credit unions already fund the budget for NCUA. Under the Administration's proposal for the CFPA, it also appears that the agency would be funded by the industry, meaning an additional cost burden to credit unions and their 90 million members. Recognizing that more should be done to help consumers, we would propose that, rather than extending the CFPA to federally insured depository institutions, each functional regulator of federally insured depository institutions strengthen or establish a new office on consumer affairs. Such an office should report directly to the Presidential appointees at the regulator and be responsible for ensuring that the regulator is looking out for consumer concerns in writing rules, supervising and examining institutional compliance, and administratively enforcing violations. Consumer protection offices at the functional regulators will ensure that those regulating consumer issues at financial institutions have knowledge of the institutions they are examining and can provide expertise and guidance on consumer protection. This is particularly important to credit unions, as they are regulated and structured differently than others in financial services. We believe that it is imperative that any regulator examining credit unions should understand their unique nature. This approach would strengthen consumer protection while not adding unnecessary regulatory burdens on our Nation's financial institutions. We are pleased to see that NCUA Board Chairman Michael Fryzel recently announced the creation of such an office at NCUA. Finally, some have advocated expanding the Community Reinvestment Act (CRA) as part of the regulatory reform effort. NAFCU opposes extending CRA to Federal credit unions. Federal credit unions are already examples of CRA in action. Furthermore, analysis of 2007 HMDA data shows that despite banks and thrifts being subject to CRA requirements, credit unions regularly outperform them in terms of lending to low-income and minority populations. Adding a CRA requirement to Federal credit unions would be a solution in search of a problem.Conclusion In conclusion, the current economic crisis is having an impact on credit unions in rural areas, but many are continuing the serve their members well. The enactment of legislation earlier this year, such as S. 896 and the temporary corporate credit union stabilization fund it created, are providing relief, but additional statutory challenges remain. We urge the Subcommittee to support efforts to remove the credit union member business lending cap and to clarify that ability of credit unions of all charter types to add underserved areas. Finally, while there are positive aspects to consumer protection in regulatory reform, we believe that Federal credit unions continue to warrant an independent regulator that handles both safety and soundness and consumer protection matters. I thank you for the opportunity to appear before you today on behalf of NAFCU and would welcome any questions that you may have. FOMC20080805meeting--132 130,MR. KOHN.," Thank you, Mr. Chairman. Like others around the table, I made only small revisions to the central tendency of my forecast going forward as a result of the developments of the intermeeting period, maybe a slight reduction in the path of output and a quicker decline in headline inflation owing to the oil prices. But I think more important than any shift in central tendencies is the sense that the information tends to reinforce--to reduce the uncertainties around--the basic contours of a projection in which the economy operates with a wider output gap and a lower inflation rate on balance over the next 18 months or so than it has over recent quarters. About the output gap, the incoming information strongly suggests that we are on a trajectory that at least for some time will have the economy growing appreciably below the growth rate of its potential. The most obvious evidence is the persistence of a soft labor market--continuing declines in employment and no sign of near-term strengthening in the initial claims data. I agree that the declines in employment, as several of you have pointed out, are not consistent with a recession, but they're certainly not consistent with the economy growing close to its potential. You need another 150,000 or 200,000 jobs rather than minus 60,000, which is where we are now. So I think the economy is likely to grow below potential for some time. Even on the spending side, the decline in consumption in June, when rebate checks were continuing to hit bank accounts, and a further sharp drop in auto sales in July might be early signs that households are beginning to pull back under pressure from higher energy prices, job worries, declining house values, and reduced credit availability. To be sure, one month's consumption data along with auto sales, which are subject to all kinds of idiosyncratic influences, are not enough to justify a major change in outlook. But as President Lacker noted, household spending has for some time been a source of downside risk to the forecast. At some point, household spending could begin to reflect attitudes, and this information at a minimum seems to underline those risks as well as to point to sluggish growth of spending in the third quarter. Soggy economic news has extended to our trading partners, where actual activity and expected activity also have been marked down. The tone of news from abroad has been decidedly downbeat, as those economies feel the effect of weaker purchases from the United States, continuing financial strain, softening housing markets, and higher energy prices. Much as in the United States, attitudes abroad seem weaker than the data; but the euro area did report a record decline in retail sales in June this morning, and my sense is that our trading partners are facing larger downside risks to growth as well as a markdown of central tendencies. The dollar hasn't changed much on balance for four or five months now. With a stable dollar and weaker demand abroad, production in the United States will be getting a lot less cushion from net exports over the next few quarters than it did in the first half of the year. Finally, despite the downward movement in Treasury interest rates and in the expected federal funds rate path, financial conditions for households and businesses have tightened since the last FOMC meeting. Savers and intermediaries have become even more cautious amid concerns about deepening losses spreading beyond subprime mortgages, about the safety of uninsured deposits at regional banks, high volatility in markets, and the possible weakening of the underlying macro situation. Lenders are hunkering down to endure a long period of rising credit problems and great uncertainty. I don't think we need to rely on anecdotes here. Mortgage interest rates have actually risen on balance, as have corporate bond yields across many risk categories; and in many of these cases, the nominal interest rates are at least as high as or in some cases much higher than they were last August when the federal funds rate was at 5�. Banks continue to tighten terms and standards for nearly all categories of loans. Equity prices have fallen, adding to the downward pressure on wealth from declining house prices, and I think these developments underscore the very slow recovery likely in financial markets and the possible downside risks relative to even that very gradual improvement that many of us were expecting. The tightening of conditions is damping credit growth broadly defined and will constrain, at least to some extent, spending going forward, delaying the return to trend or above-trend growth. Thus although uncertainties remain quite elevated, I think we can be a little more confident that the economy will be subject to further quarters of below-trend growth and declining resource utilization. Furthermore, with housing prices still falling fast, inventories of homes still high, and financial markets quite skittish, the downside risks even to a slightly lower central tendency forecast remain high. Greater confidence that output will grow below potential for a time contributes to a little more optimism on my part that inflation will, indeed, come down substantially over the coming quarters. An environment of rising unemployment and declining capacity utilization is not one in which businesses or labor will find it easy to restore real incomes or raise profit margins after the increase in energy prices. With regard to that increase in energy and other commodity prices and how it affects headline inflation, I like to differentiate pass-through from spillover. I think we can expect passthrough. Pass-through to consumer prices of the higher energy and commodity prices is part of the adjustment process by which demand gets damped and by which consumers realize, unfortunately, the lower real income that they get from the adverse terms of trade. So the fact that businesses are able to pass through higher commodity prices and higher petroleum prices I don't find all that worrisome, provided that they're passing through a one-time increase in prices rather than a continuing rise. I think we have some further evidence that at least to date--things could change, I admit--what we are seeing is a pass-through of a one-time rise rather than some continuing increases. For one thing, commodity prices, as shown in Bill's chart, have flattened out or actually declined in the past few months. So presumably that pass-through is a one-time jump, if that's what they're doing, passing through those prices. Second, I think we saw in the GDP chain-type price indexes that the price of domestic value added increased at an annual rate of only 1.1 percent in the second quarter--which suggests to me that, at least through the second quarter, there was very little spillover from these higher commodity and energy prices to the stuff we produce here at home. Also, labor compensation growth, which could be a lagging indicator, at least to date hasn't increased. If anything, it has slowed a little further, which along with relatively robust productivity growth is holding down unit labor costs. Headline inflation--the goods and services that people purchase--has been high. Energy prices are being passed through, but I think to date there's no evidence or very little evidence that it's spilling over into other prices in the economy. So this is about the adjustment to relative prices. Obviously the decline in oil prices, if it holds, will be helpful on the inflation front, both in its direct effect on headline inflation and its indirect effect on inflation expectations. We finally have evidence of two-way risk in oil prices, and that should make us more comfortable with an assumption of stable prices as a reasonable basis for forecasting. Other recent contributors to higher price levels have also become less averse. As I mentioned, other industrial commodity prices have leveled out or declined, and the dollar has been relatively stable in recent months. Although I feel a little more confident about the expectation of lower inflation going forward, I agree that upside risks still prevail. Core inflation has ticked up. Headline inflation will be high for some time and could threaten to spill over through increases in inflation expectations. Oil and commodity price declines are largely an endogenous response to perceptions of weak growth, and if those perceptions turn around, so will those prices. Longer-term inflation expectations remain elevated by some measures and are probably less well anchored than they were a couple of years ago, before oil and commodity prices rose so much. In sum, I see upside risks to both the inflation gaps and the output gaps as having diminished over the intermeeting period, and we'll get to the implications of that for policy in the next part of the meeting. " FinancialCrisisInquiry--693 ZANDI: I think the Capital Purchase Program was a necessary condition for stabilizing the financial system. I don’t think the system would have stabilized without that injection of capital at that point in time, so I think that was absolutely vital. I think the thing that really ended the—the panic once and for all were the stress tests. I think they were incredibly therapeutic, to my surprise. I—I did not expect them to go as well as they did. And, in fact, I think that is a very therapeutic process to be adopted going forward. We do a lot of risk modeling. We try to incorporate economic information into the risk processes, the financial institutions, something we’ve done in the—in the wake of the crisis. And it is to my great surprise that these institutions did not have any systematic way of stressing their portfolios. And actually some of the larger institutions—interestingly enough, they are quite sophisticated, but they’re very siloed. So the credit card folks would do it one way; the mortgage guys would do it another way; the corporate bond— the corporate lending folks another. There was no sort of across the entire balance sheet. And this stress test process for the 19 bank-holding companies was, in fact, that, and it was, I thought, very well done and ultimately restored confidence in the system and is January 13, 2010 where we are today. Now, the one part of the system that’s not working and the system will not work well without it is the process of securitization. Ironically, that’s what got us—the flawed securitization process goes to your point. That’s how we got that homeownership rate up. That’s how we got all those bad loans being made. And $2 trillion in private bond issuance in 2006 at the height of the... CHRG-110shrg50417--28 PENNSYLVANIA Ms. Wachter. Thank you. Chairman Dodd and other distinguished Members of the Committee, it is my honor to be here today to provide my perspective on the ongoing mortgage crisis and how and why stabilizing the housing market is essential to stabilizing the broader U.S. economy. The ongoing crisis in our housing and financial markets derives from an expansion of credit through poorly underwritten and risky mortgage lending. Until the 1990s, such lending was insignificant. By 2006, almost half of mortgage originations took the form of risky lending. The unprecedented expansion of poorly underwritten credit induced a U.S. housing asset bubble of similarly unprecedented dimensions and a massive failure of these loans and to today's system breakdown. Today's economic downturn could become ever more severe due to the interaction of financial market stress with declines in housing prices and a worsening economy feeding back in an adverse loop. We have the potential for a true economic disaster. I do not believe we will solve our banking liquidity problems if the housing downturn continues, and the housing market decline shows no signs of abating. Moreover, despite bank recapitalization and rescue efforts, economically rational loan modifications that would help stabilize the market are not occurring. We must directly address the need for these loan modifications in order to halt the downward spiral in mortgage markets and the overall economy. It is critical to bring stability to the housing market. While today prices may not be far from fundamental levels, just as they overinflated going up, there is great danger for overcorrection on the downside. In our current situation, as prices fall, market dynamics give rise to further expectations of price decline, limiting demand, and supply actually increases due to increased foreclosures, causing prices to decline further. A deflationary environment with demand decreases due to expectations of further price decline was in part responsible for Japan's ``lost decade'' of the 1990s. We cannot rely on a price decrease floor at currently market-justified fundamental levels if we rely on market forces alone, even, it appears, if augmented by the interventions so far of the Federal Reserve and Treasury. In fact, home inventories are not declining, and up to half of the inventory of homes are being sold through foreclosures at fire-sale prices in many markets. The Case-Shiller Price Index reflects the massive deterioration of housing wealth so far. Since the peak in 2006, housing values have fallen over 20 percent. While another 5- to 10-percent fall could bring us to market-clearing levels, actual price declines may far exceed this. And as house prices decline, these declines undermine consumer confidence, decrease household wealth, and worsen the system-wide financial stress. While banks have been recapitalized through the Capital Purchase Program--and there is discussion of the use of this funding for acquisitions--as yet, there is little evidence that bank lending has expanded. In order for the overall economy to recover and for conditions not to worsen, prudent lending to creditworthy borrowers needs to occur. Without financing for everyday needs, for education, small business investment and health, American families are at risk. And today the U.S. economy and the global economy are depending on the stabilization of their financial well-being. Moreover, the plans that are already in place do not appear to be leading to the modification of loans at the scale necessary in order to assure a market turnaround at fundamental levels instead of a severe and ongoing overcorrection. Barriers to economically rational loan modifications include conflicting interests, poor incentives, and risks of litigation to modify loans, particularly to modify loans deriving from mortgage-servicing agreements. Given the freefall in housing markets and its implications for credit conditions and the overall economy, there is a need for policies to address these barriers today. It is both necessary and possible to take effective action now. While housing values may not be far from fundamental levels, as housing values continue to fall, resolving the problem will become increasingly difficult and costly. Thus, solutions that are now possible may not be available going forward. Without expeditiously and directly addressing the housing market mortgage crisis, the Nation is at risk. Thank you. " CHRG-111hhrg53234--10 Mr. Kohn," Thank you, Chairman Watt, Ranking Member Paul, and members of the subcommittee. I do appreciate this opportunity to discuss with you the important public policy issues associated with the Congress' grant to the Federal Reserve of a substantial degree of independence in the conduct of monetary policy and the interaction of this degree of independence with the possible enhancement of our responsibilities for financial stability. A well-designed framework for monetary policy includes a careful balance between independence and accountability. In 1977, the Congress amended the Federal Reserve Act by establishing maximum employment and price stability as our monetary policy objectives. At the same time, the Congress has correctly, in my view, given the Federal Reserve considerable scope to design and implement the best approaches to achieving those statutory objectives, subject to a well-calibrated system of checks and balances in the form of transparency and accountability to the public and the Congress. Considerable experience shows that this approach tends to yield a monetary policy that best promotes economic growth and price stability. Operational independence, that is, independence to pursue legislative goals, reduces the odds on two types of policy errors that result in inflation and economic instability. First, it prevents governments from succumbing to the temptation to use the central bank to fund budget deficits; and second, it enables policymakers to look beyond the short term as they weigh the effects of their monetary policy actions on price stability and employment. The current financial crisis has clearly demonstrated the need for the United States to have a comprehensive and multifaceted approach to containing systemic risk. The Administration recently released a proposal for strengthening the financial system that would provide new or enhanced responsibilities to a number of Federal agencies, assigning to the Federal Reserve certain new responsibilities for overseeing systemically important financial institutions and payment clearing and settlement arrangements. These incremental new responsibilities are a natural outgrowth of the Federal Reserve's existing supervisory and regulatory responsibilities. The Federal Reserve already regulates bank holding companies, which now include large investment banks, and we have been moving to incorporate a more macroprudential approach to our supervision and regulatory programs, as evidenced by the recently completed Supervisory Capital Assessment Program. The Federal Reserve has also long been a leader in the development of strong international risk management standards for payment clearing and settlement systems, and we have implemented these standards for the systems we supervise. In our supervision of bank holding companies, and our oversight of some payment systems, we already work closely with other Federal and State agencies. These responsibilities and close working relationships have not impinged on our monetary policy independence, and we do not believe that the enhancements to our existing supervisory and regulatory authority proposed by the Administration would undermine our ability to pursue our monetary policy objectives effectively and independently. Our independence in the conduct of monetary policy is accompanied by substantial accountability and transparency. For instance, the Federal Reserve reports on its efforts to achieve its statutory objectives in the semiannual monetary reports and associated testimony. The Federal Open Market Committee releases a statement immediately after each regularly scheduled meeting and detailed minutes of the meeting on a timely basis. We publish summaries of the economic forecasts of FOMC participants 4 times a year, and Federal Reserve officials frequently testify before the Congress. In addition, the Federal Reserve provides the public and the Congress with detailed annual reports on the consolidated financial activities of the system. These are audited by an independent public accounting firm. We publish a detailed balance sheet on a weekly basis. This year, we expanded our Web site to include considerable background information on our financial condition and our policy programs. We recently initiated a monthly report to Congress on Federal Reserve liquidity programs that provides even more information on our lending, associated collateral, and other facets of the programs established to address the financial crisis. The Congress also recently clarified the GAO's ability to audit the Term Asset-Backed Securities Loan Facility, a joint Treasury-Federal Reserve initiative, and it granted the GAO new authority to conduct audits of the credit facilities extended by the Federal Reserve to single and specific companies under the authority provided by Section 13(3) of the Federal Reserve Act. As this committee is aware, the Federal Reserve is already subject to frequent audits by the GAO on a broad range of our functions, including, for example, supervision and regulatory functions. The Congress, however, has purposefully and for good reason excluded monetary policy deliberations and operations from the scope of potential GAO audits. The Federal Reserve strongly believes that removing the statutory limits on GAO audits of monetary policy matters would be contrary to the public interest. Financial markets likely would see the grant of such authority as tending to undermine monetary independence, and this would have adverse consequences for interest rates and economic stability. An additional concern is that permitting GAO audits of the broad facilities the Federal Reserve uses to affect credit conditions could reduce the effectiveness of these facilities in helping promote financial stability, maximum employment, and price stability. Thank you, Mr. Chairman, for inviting me to present the Board's views, and I look forward to answering your questions. [The prepared statement of Vice Chairman Kohn can be found on page 57 of the appendix.] " CHRG-109shrg21981--102 Chairman Greenspan," Well, no, it---- Senator Schumer. Because it will only increase full funding if you dramatically cut a benefit. You have to do other changes than simply move one to the other. What we are trying to get at here is not the overall change that is needed, and I do not think anyone disputes what you say, but whether setting up a private account--under current conditions, not starting from scratch--does anything to alleviate the problem. " CHRG-110hhrg46594--481 Mr. Foster," Thank you. First, I was wondering if you could give us some estimate of what you consider the aggregate overcapacity of the automobile industry and just in normal economic times right now in terms of the--the aggregate overcapacity. I think there is a general consensus that even if things are maintained, you know, relatively normal economic conditions, there was an overcapacity both in terms of the number of vehicles built per year, the number of dealerships, the number of brands supported by the manufacturers and so on. And so you could talk about those in optimistic scenarios in which things return to normal or pessimistic ones in which they continue. And I was wondering if you have any numbers on that. " CHRG-110hhrg46593--14 Mr. Bernanke," Thank you. Chairman Frank, Ranking Member Bachus, and other members of the committee, I appreciate having this opportunity to review some of the activities to date of the Treasury's Troubled Asset Relief Program, or TARP, and to discuss recent steps taken by the Federal Reserve and other agencies to support the normalization of credit markets. The legislation that created the TARP put in place a Financial Stability Oversight Board to review the actions of the Treasury in administering the program. That oversight board includes the Secretary of the Treasury, the Secretary of Housing and Urban Development, the Chairman of the Securities and Exchange Commission, the Director of the Federal Housing Finance Agency, and the Chairman of the Federal Reserve Board. We have met 4 times, reviewing the operational plans and policy initiatives for the TARP and discussing possible additional steps that might be taken. Officers for the oversight board have been appointed, and the Federal Reserve and other agencies are providing staff support for the board. Minutes of each meeting are being posted to a special Web site established by the Treasury. In addition, staff members of the agencies whose heads are participating in the oversight board have met with staff from the Government Accountability Office to explore strategies for coordinating the oversight that the two bodies are required to perform under the enabling legislation. The value of the TARP in promoting financial stability has already been demonstrated. The financial crisis intensified greatly in the latter part of September and spread to many countries that had not yet been touched by it, which led to grave concerns about the stability of the global financial system. Failure to prevent the international financial collapse would almost certainly have had dire implications for both the U.S. and world economies. Fortunately, the existence of the TARP allowed the Treasury to act quickly by announcing a plan to inject $250 billion in capital into U.S. financial institutions. Nine large institutions received the first $125 billion, and the remainder is being made available to other banking organizations through an application process. In addition, the Federal Deposit Insurance Corporation announced that it would guarantee non-interest-bearing transaction accounts at depository institutions and certain other liabilities for depository institutions and their holding companies. And the Federal Reserve expanded its provision of backstop liquidity to the financial system. These actions, together with similar actions in many other countries, appeared to stabilize the situation and to improve investor confidence in financial firms. Notably, spreads on credit default swaps for large U.S. banking organizations, which had widened substantially over the previous 2 weeks, declined sharply on the day of the joint announcement. Going forward, the ability of the Treasury to use the TARP to inject capital into financial institutions and to take other steps to stabilize the financial system, including any actions that might be needed to prevent a disorderly failure of a systemically important financial institution, will be critical for restoring confidence and promoting return of credit markets to more normal functioning. As I noted earlier, the Federal Reserve has taken a range of policy actions to provide liquidity to the financial system and thus promote the extension of credit to households and businesses. Our recent actions have focused on the market for commercial paper, which is an important source of short-term financing for many financial and nonfinancial firms. Normally, money market mutual funds are major lenders in commercial paper markets. However, in mid-September, a large fund suffered losses and heavy redemptions, causing it to suspend further redemptions and then close. In the next few weeks, investors withdrew almost $500 billion from prime money market funds. The funds, concerned with their ability to meet further redemptions, began to reduce their purchases of commercial paper and limit the maturity of such paper to only overnight or other very short maturities. As a result, interest rate spreads paid by issuers on longer maturity commercial paper widened significantly, and the issuers were exposed to the costs and risks of having to roll over increasingly large amounts of paper each day. The Federal Reserve has developed three programs to address these problems. The first allows money market mutual funds to sell asset-backed commercial paper to banking organizations which are then permitted to borrow against the paper on a nonrecourse basis from the Federal Reserve Bank of Boston. Usage of that facility peaked at around $150 billion. The facility contributed importantly to the ability of money funds to meet redemption pressures when they were most intense and remains available as a backstop should such pressures re-emerge. The second program involves the funding of a special purpose vehicle that purchases highly rated commercial paper issued by financial and nonfinancial businesses at a term of 3 months. This facility has purchased about $250 billion of commercial paper, allowing many firms to extend significant amounts of funding into next year. A third facility expected to be operational next week will provide a liquidity backstop directly to money market mutual funds. This facility is intended to give funds confidence to extend significantly the maturities of their investments and reduce over time the reliance of issuers on sales to the Federal Reserve special purpose vehicle. All of these programs, which were created under section 13(3) of the Federal Reserve Act, must be terminated when conditions in the financial markets are determined by the Federal Reserve to no longer be unusual and exigent. The primary objective of these and other actions we have taken is to stabilize credit markets and to improve the access of credit to businesses and households. There are some signs that credit markets, while still strained, are improving. Interbank short-term funding rates have fallen notably since mid-October, and we are seeing greater stability in money market mutual funds and in the commercial paper market. Interest rates and higher rated bonds issued by corporations and municipalities have fallen somewhat, and bond issuance for these entities rose a bit in recent weeks. The ongoing capital injections under the TARP are continuing to bring stability to the banking system and have reduced some of the pressure on banks to deleverage, two critical first steps towards restarting flows of new credit. However, overall, credit conditions are still far from normal with risk spreads remaining very elevated and banks reporting that they continued to tighten lending standards through October. There has been little or no bond issuance by lower rated corporations or securitization of consumer loans in recent weeks. To help address the tightness of credit, on November 12th, the Federal banking agencies issued a joint statement on meeting the needs of creditworthy borrowers. The statement took note of the recent strong policy actions designed to promote financial stability and improve banks' access to capital and funding. In light of those actions, which have increased the capacity of banks to lend, it is imperative that all banking organizations and their regulators work together to ensure that the needs of creditworthy borrowers are met in a manner consistent with safety and soundness. As capital adequacy is critical in determining a banking organization's ability and willingness to lend, the joint statement emphasizes the need for careful capital planning, including setting appropriate dividend policies. The statement also notes the agency's expectation that banking organizations should work with existing borrowers to avoid preventable foreclosures which can be costly to all involved: the borrower; the lender; and the communities in which they are located. Steps that should be taken in this area include ensuring adequate funding and staffing of mortgage servicing operations and adopting systematic, proactive, and streamlined mortgage loan modification protocols aimed at providing long-term sustainability for borrowers. Finally, the agencies expect banking organizations to conduct regular reviews of their management compensation policies to ensure that they encourage prudent lending and discourage excessive risk-taking. Thank you. I would be pleased to take your questions. [The prepared statement of Chairman Bernanke can be found on page 139 of the appendix.] " FOMC20060510meeting--231 229,MS. DANKER.," I will be reading the directive from page 29 of the Bluebook. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 5 percent.” And the risk assessment from the press release that’s being handed around: “The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.” Chairman Bernanke Yes Vice Chairman Geithner Yes Governor Bies Yes President Guynn Yes Governor Kohn Yes Governor Kroszner Yes President Lacker Yes Governor Olson Yes President Pianalto Yes Governor Warsh Yes President Yellen Yes" FOMC20070816confcall--100 98,MR. MISHKIN.," May I just ask a question of Brian on this? We know clearly that under normal conditions, particularly with the 100 basis point penalty, we want this to be a standing facility with no questions asked. Given the situation that’s so unusual in this context and the fact that what we’re doing now is clearly temporary, there is an issue here that we might have some cases in which we cannot have purely no questions asked, but close to it. Would that be a problem?" FOMC20070321meeting--183 181,MS. MINEHAN.," I fully agree with Governor Kroszner’s idea that thinking that in this short form we can explain all of that is risky. Given the volatility that we have recently seen and the concern, which many have expressed, that this Committee is out to save people from stock market problems, I just think that we run a risk by highlighting “financial conditions” in our statement right now." CHRG-110shrg50416--107 Mr. Kashkari," Again, Senator, I am not trying to be evasive. It is hard to predict the policy process. I don't know if it is days or if it is weeks. It is something we are very focused on right now. Senator Casey. Well, I would urge you and I would urge the administration to move with dispatch, because one thing, as Senator Dodd has said and others, is that there is a sense of a lack of urgency. I realize this stuff takes--this work, I should say, takes a lot of close examination and it is not easy to develop new programs. But when you juxtapose the foreclosure filing reality, the impact that is having on neighborhoods, the jobless rate numbers, which keep spiking up--we are headed to maybe a million job losses this year. In Pennsylvania, we have got 67 counties, almost half of them have unemployment rates above 6 percent. About 15 of them have unemployment rates above seven as of the last monthly county-by-county number. And then you also have a lot of taxpayers looking to Washington and they don't--and I am just saying this as an opinion of mine, but I think it is shared by a number of people--they don't have a lot of confidence in the current President to be able to deal with this. We have two candidates for President, neither of which has the authority to deal with this. They look to the Congress and they are not sure they can identify one person there. So what Treasury does and what every institution represented at this table does is critically important in any context, but especially in the context of the juxtaposition of big problems in people's lives and a vacuum or a lack of leadership that is focused on a singular person or a single institution. So your actions and your decisions and your sense of urgency is critically important to inspiring--I know you have got to worry about market confidence, but I think also taxpayer confidence has worn pretty thin. Thank you, Mr. Chairman. " CHRG-111shrg56262--3 STATEMENT OF SENATOR JIM BUNNING Senator Bunning. Thank you, Mr. Chairman. All it takes is a short amount of time studying the market for asset-backed securities to realize really how complicated it is. Right now there is no basic private securitization market, especially for mortgages. I hope this hearing will help us all get a better understanding of the market and what we can do and should be done to make it work better. In theory, securitization is a great idea that brings more capital to the financial markets, leading to more loans for individuals and businesses. Done properly, that is a good thing. But as we saw last year, if it is done wrong, it can lead to disaster. The natural first question is whether the problems we saw were a result of a bad theory or bad execution. For several reasons, I think what happened was bad execution as a result of other bad policies and regulations. Probably the biggest factor that led to the problems in the securitization market were artificial demand created by bank capital rules favoring highly rated securities over whole loans. That artificial demand found a home in residential mortgage securities thanks to the GSEs' loose underwriting and easy money. And the rating agencies enabled it all. We should start by fixing those problems. Once the bad incentives and artificial demand are taken away, real risk analysis can be done, and price can be based on real value. The Government will not have to solve all the problems because investors will demand more protections from the issuers. For example, the model where issuers were paid by the number of deals closed and loan originators passed on all responsibility and collects profits up front will not be tolerated by investors in the future. That will lead to a solution tailored to a particular asset and flexible enough to be changed as the market evolves. I hope our witnesses will comment on these ideas and provide some of their own, because we really need them. Thank you. " CHRG-111hhrg48868--624 Mr. Liddy," Mr. Campbell, if I could, my comment about markets getting worse has more to do with selling assets. It's selling our really good life insurance company in Asia or what have you. The rundown of the book of business can happen in an orderly way. On some trades we make money, on some trades we lose money. The goal would be not to lose any money on that business so we don't have to put more money into it from the Federal Reserve. That's entirely possible in almost any market condition as long as there's someone there monitoring the book of business. If there's no one there, you have a problem. " CHRG-110shrg50420--291 Chairman Dodd," Thank you very much. Senator Schumer. Senator Schumer. Thank you, Mr. Chairman, and thank you to the witnesses. Just to sort of sum up, I think, where we are at, we realize just letting you fail would be cataclysmic, as Dr. Zandi says, far worse than the costs that you have outlined. Second, bankruptcy, I think it is pretty clear, is not a viable option because no one is going to buy a car from a bankrupt company, and it takes so long and it is so complicated that it does not work. And I would--this is my own 2 cents. I think one of these pre-packed bankruptcies has similar problems because you cannot bring the others in. So we have to do something. That is on the side of making sure you are viable, which I think I want to do and I think most of us want to do. On the other hand, our real problem is this: I think that there is a general view that we want to see the conditions before we give you the money, and you folks sort of want the money and say let the conditions work out. Mr. Nardelli said let us see how things are on March 1st. And in all due respect, folks, I do not think there is the faith that those next 3 months will work out given the past history. And so what I think some of us are searching for us here is a way that we can make sure you continue, make sure you are viable on into the future. My third point is make sure that the burden is spread evenly. I think the workers, Mr. Gettelfinger, have taken more of the hit, and I have not heard much about the bond holders, the lenders who are getting paid 12 percent, and people like that. And the only way this is going to work is if everybody gives. If everybody gives. And so the question I have is: Why isn't the best solution for us to pass something on Monday--and, again, I do not care where the money comes from, frankly. OK? That is a dispute that others have. I would take it out of the TARP, if need be, temporarily out of the 136 funds. That to me is not the issue. The issue is how are these real conditions that are created and imposed by someone who is overlooking you outside. So I do not like the words ``oversight board,'' like Mr. Dodaro. Second, who is going to do this negotiating? You may not have leverage, frankly, over the dealers or over the bond holders or over the others, except to threaten to go out of business? Which is not very good leverage. You are saying, well, I will cut my nose to spite my face. Why isn't the best solution the one I was sort of positing before, that we pass legislation that gives, you know, a specific amount of money, not a small sum, to a designee of the President in a certain sense. He has control. It could be the Treasury Secretary. That person quickly calls in all the players and says we have some carrots for you. We not only have money, but we have the ability. We give him the ability maybe to impose for a period of time a guarantee of the warranties and maybe even some help with the funding, because the funding is part and parcel. But, in return, every one of you around the table, you executives, the workers--which have already given quite a bit based on yesterday's statement--the bond holders, the dealers, everyone gives. That seems to me to be the best model given that we do not have much time, that there is not much taste for giving the money and then seeing if the conditions are met down the road, and that the alternatives of either letting you go under a bankruptcy are the worst. And you have said you agree with the Chrysler model when Senator Dodd posited the question to each of the three of you. Would you agree with this kind of model? What do you think of the--what are the pros and cons? Would you agree to the kind of thing that I am mentioning here? Go ahead, Mr. Wagoner. " CHRG-110hhrg46596--431 Mr. Kashkari," Congressman, I appreciate the feedback. And, clearly, we have heard the message, and we understand the concerns that have been raised by us adjusting our strategy as we move forward. At the same time, we have had to move very quickly, as I have said, and market conditions have changed so quickly. I feel good about the actions that we have taken, that they were the right actions to take to try to stabilize the system. " FOMC20080130meeting--60 58,MR. DUDLEY.," Another thing that is not very well known is what their assets consist of. We have rating buckets, but we don't know what those ratings actually apply to. We don't know who they have reinsurance with. Some people think that they're reinsuring each other to an extent or they have reinsurance with subsidiaries that they own so that the insurance is not at arm's length. So there's quite a bit of cloudiness about what their true condition is. " CHRG-111shrg50815--58 Mr. Levitin," Well, here is the problem with Mr. Clayton's story. It is that he is saying you can just say no. If a consumer doesn't like a prospective rate increase, the consumer can walk away. But that is not costless. There is a lot of lock-in with credit cards. If you want to walk away from a card because you don't like what the issuer is doing, it is not that simple. You have to go and find a new card. That takes some time. There are some transaction costs there, not high, but there are some, and you take a hit to your credit report. If you have a line of credit that was functioning just fine and you close it, that hurts your credit score. Walking away is not costless, and I believe Professor Ausubel has a study on this and I should defer to him for a characterization of it, but if I recall, I think he estimated the costs of switching a card being around $150 in total costs to a consumer. Senator Reed. Before I go to the Professor, just a response to my initial question. There is no disincentive to raising rates, and another particular question, there are certain categories of fees or charges that are prohibited after the 18-month period. If those fees or charges exist on that date for card customers, will they stay in effect or would they have to be conformed? " FOMC20060328meeting--108 106,CHAIRMAN BERNANKE.," Thank you. Let me just highlight a theme that President Guynn and President Minehan both mentioned, which is that some of the tightest labor market conditions are for the most skilled workers. It seems to me that normally in a business-cycle expansion the lower-skilled workers tend to benefit at least as much as highly skilled workers. And I just want to raise this theme for the research people and for the other principals, to see if something is unusual here or if we’re just misinterpreting what is going on." FOMC20080805meeting--186 184,CHAIRMAN BERNANKE.," Thank you. I want to thank everyone for your comments today. I know we don't have agreement around the table, but as somebody once said, if everybody agrees, then everybody except one is redundant. [Laughter] I listened very carefully to what has been said. I understand your concerns. I think hard about them--I do every day. As we go forward, we will obviously continue to have these fruitful discussions. I do think that we need to continue to clarify this exit strategy issue. One point I would make, and Governor Warsh alluded to it, is that we need to think of this as a state-dependent rather than a time-dependent strategy. We need to be clear not so much as to whether we are or are not going to raise rates but under what circumstances and why and what our objectives are. On that basis, I reiterate that my greater attention recently to financial and real conditions has to do with my view of the risks rather than my objective function. I recommend no action today and alternative B. There were a number of suggestions for changes. I think I will avoid them just to avoid further controversy. My reasons for suggesting alternative B were well stated by President Pianalto. It's hard to judge. I don't know what the markets will make of this, but my intention is for it to be slightly hawkish--to indicate a slight upward tilt in policy--which has several functions. First, if we don't move, it emphasizes our ongoing concern with inflation and perhaps provides some prophylactic protection with respect to expectations and so on. On the other hand, if conditions do warrant action, and it could be quick action, at least we will have provided the markets with some warning and some indication of our concern about this issue. So that's my recommendation. Any comments? Would you call the roll? " CHRG-111shrg53085--207 PREPARED STATEMENT OF DANIEL A. MICA President and Chief Executive Officer, Credit Union National Association March 24, 2009 Chairman Dodd, Ranking Member Shelby, and Members of the Committee, on behalf of the Credit Union National Association (CUNA), I appreciate the opportunity to appear before you to express the need for maintaining an independent federal regulatory agency for federally insured credit unions. I am Dan Mica, the President and CEO of CUNA. CUNA is the largest credit union advocacy organization in this country, representing approximately 90 percent of our Nation's 8,000 state and federal credit unions and their 92 million members. Mr. Chairman, I applaud you for addressing this pressing issue. The collapse of the financial system has exposed flaws in the regulation of U.S. financial institutions, and these flaws absolutely must be addressed. I suggest, however, that most of the current crisis was caused by the actions of relatively unregulated financial institutions, and by compensation practices at even regulated institutions that encouraged excessive risk taking. I can assure you that neither of these two factors exists at credit unions. Credit unions did not in any way contribute to the current financial debacle and their current regulatory regime coupled with the cooperative structure militates against credit unions ever contributing to a financial crisis. Therefore it is imperative that credit unions not be swept up in the tide of regulatory reform that is so essential for some other parts of the financial system. Credit unions' unique mission, governance structure, and ownership structure necessitate an independent federal regulator in order to ensure that the credit union model is not eroded as a result of the misapplication of bank regulations to credit union operations. Unlike for-profit banks, credit unions are not-for-profit institutions that exist to serve their member-owners rather than to profit from them. Also unlike banks, the members of the credit union own their institutions, which are subject to a democratic, one-member-one-vote system irrespective of members' account balances or any other factor. I am aware that, on Friday, March 21, NCUA did place two wholesale, or ``corporate,'' credit unions into conservatorship. Those institutions serve only other credit unions, not people, and are completely different from the 8,000 retail, or ``natural person,'' credit unions in this country. Natural person credit unions have very narrow investment powers and very conservative investment policies, whereas corporate credit unions enjoy broader investment powers. Essentially, what created losses at the two corporate credit unions were declines in the values of mortgage-backed securities in which they had invested. Although these securities were originally AAA-rated and appeared prudent when they were made, market developments provide to the contrary. Let me emphasize two points here: first, few, if any, of the mortgages backing the securities were originated by credit unions; and second, the credit union system itself is funding the losses on these investments. That is not to say that we would reject some government help with the problem; we would prefer some help, which we would pay back, spreading the losses over time. But we expect to pay for the problem ourselves, and the problem says nothing about the condition or operations of credit unions that you and I can join. Getting back to the current discussion of regulatory restructuring, let me call your attention to the fact that, for decades, the banking industry has sought the extinction of credit unions in this country. Rather than pursue this goal in the marketplace, banks often seek to leverage legislation and regulations against credit unions through intense, well-funded lobbying and litigation. We urge Congress not to allow its deliberations about financial regulatory restructuring regulatory to become a vehicle for more of these tactics. The loss of the diversity, conservative management, and consumer ownership of credit unions through the creation of inappropriate regulatory mechanisms would be tragic not only for credit unions, but also for the 92 million consumers who take advantage of credit union service. As I explain in more detail below, regulatory restructuring could force credit unions into the mold of the banks if restructuring is not approached with care.Changes to the Credit Union Regulatory Structure Should Be Tailored to the Need Although the causes of the current economic crisis are complex, few can doubt that the skyrocketing rates of mortgage loan defaults and foreclosures of the past few years were the catalyst, with the resulting drop in housing values serving to exacerbate these problems. The primary culprits were subprime mortgage loans characterized by high rates with large interest-rate re-sets, negative amortization, lack of sufficient underwriting, or other indicators of fraud. Unlike other types of financial institutions, credit unions originated few if any of the subprime mortgage loans with these characteristics and have not otherwise been the cause of our current economic circumstances. Credit unions' generally conservative lending practices and ongoing efforts to place the needs of members over profits have distinguished them from those who made unscrupulous loans in recent years. This distinction has been recognized by many in Congress. For example, Congressman Barney Frank (D-MA) has publicly stated that the economic crisis would never have occurred if all lenders originated loans in the same manner as credit unions. Unfortunately, the high rates of mortgage defaults and foreclosures have affected credit unions and their members as the current recession has deepened. Increased unemployment and other factors have affected the ability of some members to keep current on their mortgage, auto loan, and other obligations. Notwithstanding these difficulties, credit unions have been able to continue making loans, while other types of financial institutions have curtailed lending, and these efforts have been noted by the mainstream media. According to a March 15 Wall Street Journal article, as banks cut back on lending, credit union loans rose by 7 percent in 2008 to over $575 billion, up $35 billion from the previous year. The article also noted that bank loans in the country declined about $31 billion during this time. We certainly recognize that the current economic circumstances highlight the need to restructure the financial regulatory system. However, we believe these efforts should focus on protecting consumers, preserving their financial choices--including through dual chartering--and limiting the systemic risk that is currently posed by institutions within the financial system which present disproportionate risk and have not been subject to sufficient regulatory oversight. Although we recognize that there are many suggestions to address these issues, such as creating a centralized systemic risk regulator or perhaps by enhancing the Federal Reserve Board's authority in the area of systemic risks, we urge Congress to exclude from the scope of such regulation smaller institutions that have shunned undue risk. Credit unions are among those in this category. By focusing on institutions whose operations and actions present the greatest risk, Congress will avoid the danger that credit unions--the very institutions that observed conservative lending and underwriting practices--could find themselves deprived not only of a voice, but even an audience, at a regulator dominated by larger, riskier institutions. We look forward to reviewing from this perspective the specific proposals and bills that will be introduced in the near future. Another caution comes from our experience with the Treasury under the past Administration and at times, the Federal Reserve Board. More specifically, credit unions and their regulator have not always had opportunities to provide input on the development of rules and policies that impact their operations to the same extent as banks. For instance, credit unions often have difficulty getting appointments with key Federal Reserve officials, and those officials routinely decline requests to appear before credit union audiences. A previous head of the Federal Deposit Insurance Corporation (FDIC) publicly called for taxation of credit unions, and the Office of Thrift Supervision, which has sometimes been short on institutions to regulate, has encouraged credit unions to convert to thrift charters. This should come as no surprise because those agencies' bank stakeholders view credit unions as their competition and spend a great deal of time, money, and effort lobbying against credit union interests, suing the National Credit Union Administration (NCUA), and using any other available means to try to put credit unions out of business. While we are hopeful that this is changing, past practices from these agencies help to illustrate why including small institutions, such as credit unions, under a large regulator focused on banks and/or other major market players would be detrimental to the interests of credit unions and their members. Since credit unions have not posed any systemic risks to the financial system or otherwise been the cause of the current economic crisis, we believe that only minimal changes need to be made to the regulatory structure of credit unions, including federally insured credit unions that are regulated by NCUA. The goal of these changes should be to enhance the quality of NCUA's regulatory structure and supervisory oversight.Credit Unions Need an Independent Federal Regulator Not-for-profit credit unions' unique mission, democratic governance, and cooperative ownership structure necessitate an independent federal regulator for credit unions. The U.S. credit union system should continue to be regulated and supervised by an independent federal agency for the following three reasons: 1. Inherent risk aversion. The cooperative structure of credit unions presents management with very different incentives related to risk taking than at for-profit institutions. These differences require a correspondingly different system of prudential regulation and deposit insurance than that which is appropriate for-profit institutions. 2. Preservation of member benefits. The cooperative structure produces substantial benefits to credit union members, which should be preserved. 3. Long-term viability. If the prudential regulation of credit unions were merged with that of for-profit depository institutions, credit unions would be transformed into for- profit institutions. The credit union way of doing business is significantly different even from mutual savings associations' because mutual thrifts are for-profit, rely heavily on proxy voting, have self-perpetuating and management-controlled boards, and almost always base their member-depositors' voting power on their account balances giving, for example, one vote for every $100 in a depositor's account. As the 105th Congress noted in the findings to the Credit Union Membership Access Act in 1998: Credit unions, unlike many other participants in the financial services market, are exempt from Federal and most State taxes because they are member-owned, democratically operated, not- for-profit organizations generally managed by volunteer boards of directors and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means. The unique cooperative structure of credit unions entails a set of incentives for managers that differ markedly from those presented to managers of for-profit institutions. The not-for-profit, democratically controlled, and member focused orientation of credit unions has a significant effect on the behavior of credit union managers. Credit unions must over time earn a positive bottom line to retain earnings to build capital, which is crucial to federally insured depository institutions. However, credit unions operate in a mode of merely generating adequate net income to build capital, rather than profit maximization. They are driven instead to maximize member satisfaction. The managers and boards of credit unions do not own stock in the credit union (there is no such thing) and they have no stock options. They therefore have much less incentive to pursue risky initiatives that might increase the stock price and hence their own wealth. One of the very driving forces that led to the current financial crisis is completely absent from credit unions. In the words of Edward Kane of Boston College Finance Department, who correctly foresaw and analyzed the savings and loan debacle of the late 1980s: ``The cooperative structure of human-person credit unions creates reservoirs for firm value and systems for distributing claims to future cash flows that differ markedly from those of other deposit institutions. These differences make it less feasible for managers to pursue and to benefit from either corrupt lending or go-for-broke strategies of risk-taking.'' The table that follows starkly illustrates Kane's point in terms of one of the most basic risks that financial institutions take on: the risk of lending. Credit union loan losses are consistently lower than at banks, across all loan types. Although credit unions and banks make similar types of loans, the credit union record of relatively conservative lending is striking. Over the past decade, bank loan charge-offs ranged from eight times higher than the credit union norm (for business loans) to nearly two times higher than the credit union norm (for non-credit-card consumer loans). These differences in loan losses stem from the natural tendency toward risk aversion induced by the cooperative structure. Further, credit unions lending is virtually exclusively consumer and small business oriented. The Treasury Department found in 2001 that: ``Over 50 percent of the [credit union business] loans reported to us by survey respondents were made for businesses with assets under $100,000 and about 86 percent of those made were to businesses with total assets less than $500,000.'' Obviously, such striking differences in natural behavior and market orientation require a different form of prudential regulation and deposit insurance. The behavioral differences seen in cooperative financial institutions also produce large societal advantages that are worth promoting and preserving. Some of these benefits are nonfinancial, such as the ability to exert control of the institution through the democratic process, access to large cooperative ATM networks, financial counseling, auto buying services, and the like. Significant financial benefits also are obvious. The credit union difference provides consumers with consistently favorable interest rates on loans and savings accounts and also gives rise to the imposition of fewer and lower fees. The table that follows highlights some of the financial advantages that were available in 2008. The 1.73 percentage point average rate differential on 4-year used car loans translates into nearly $600 in savings to the consumer who uses a credit union to finance a $15,000 vehicle. In the aggregate, CUNA economists estimate that credit unions provided $8 billion in direct financial benefits to the Nation's 92 million credit union members in the year ending June 2008. These benefits are equivalent to approximately $90 per credit union member or approximately $170 per member household. Loyal credit union members--those who use their credit union extensively--receive total financial benefits that are much greater than this average. The continued existence of these substantial societal benefits would be seriously jeopardized were the credit union regulator or credit union regulations merged into those focused on for-profit institutions. Credit unions represent just 6 percent of total depository institution assets. If the credit union regulator were merged into a for-profit regulatory body, the views, attitudes, and philosophy of the not-for-profit cooperative sector would undoubtedly be swamped and credit union behaviors would almost certainly ``morph'' into behaviors similar to those found in the for-profit sector. The not-for-profit mission and democratic governance structure of credit unions as cooperatives necessitate a fundamentally different supervisory approach at the federal level than banking supervision does. This fundamentally different approach to supervision requires an independent federal regulator that understands the unique nature of credit unions and will not become hostile to credit unions, as the FDIC and Farm Credit Administration were when they regulated federal credit unions. The United States is also far from the only country to recognize that credit unions, as not-for-profit cooperatives, require an independent credit union regulator. Most G20 countries--including Canada, Mexico, Germany, France, South Korea, Argentina, and Brazil--have recognized that having bank regulators supervise credit unions at the national level just does not work, and so have many non-G20 nations. It also worth noting that the establishment of a super-regulator in the United Kingdom, the Financial Services Authority, has failed to save British financial institutions from substantial entanglement and dislocation in the current crisis.CUNA Supports Specific, Modest Changes To Improve NCUA Operations We agree that a review of the operations of all federal financial institution regulators is certainly in order, including review of NCUA. We certainly do not mean to suggest that NCUA is a perfect regulator. Some of NCUA's issues stem from legislation. For instance, the Federal Credit Union Act limits to one the number of members of the NCUA Board who can come from credit unions. None of the other bank regulators has a similar restriction, and this one can promote an NCUA Board that has little relevant experience outside the government. Even more significant is the absence from the Act of any express authority for NCUA to address systemic risk within the credit union system. This lack has significantly restricted NCUA from doing what it needs to do to address the current crisis, and sharply contrasts with similar, but broader authority delegated to the FDIC. The fundamental point, however, as outlined above, is that it is paramount that credit unions be regulated independently. Although an independent credit union regulator is essential, we believe that there are commonalities among all financial institution regulators and that these synergies should be used to facilitate improved operations among all of these agencies. In that connection, we urged the previous Administration that the President's Working Group, which includes the Federal Reserve Board, the Federal Deposit Insurance Corporation and others, include NCUA as well. We intend to renew this request to the current Administration. We recognize that coordination among the regulators already occurs in a number of contexts. For example, the Federal Financial Institutions Examination Council (FFIEC) is a formal interagency body that prescribes uniform standards and forms for financial institution examinations. Also, the Financial Crimes Enforcement Network (FinCen) regularly convenes meetings of the Bank Secrecy Act Advisory Group (BSAAG), of which CUNA is a member. The BSAAG performs an important function by providing a forum for discussing how Bank Secrecy Act requirements can be used more effectively to combat terrorist financing. Another noteworthy example is the Financial Literacy and Education Commission, which is comprised of twenty federal agencies with the goal of developing and monitoring a national strategy to improve financial literacy in the United States. We also think that the coordination of training opportunities for the staffs of the financial regulatory agencies could help enhance efficiencies and contain agency costs. A means to facilitate these goals could be the creation of an additional interagency committee or task force to oversee these efforts and which would include equal representation from all the relevant agencies, including NCUA. This will help ensure a consistent approach to rulemaking while recognizing that the differences among financial institution charters may require different rules in specific areas.Separate Regulator for Consumer Protection Most financial transactions involving consumers are currently covered by federal consumer protection laws. These include transactions involving credit and debit cards, automated teller machine transactions and other electronic fund transfers, deposit account transactions, mortgages and home equity loans, and other unsecured credit transactions. There has been significant debate as to whether a separate agency should be established with the mission of providing consumer protections with regard to credit and other financial transactions. The Federal Reserve Board currently issues the rules to implement many of the major consumer protection laws, most of which apply to credit unions. Enforcement of these rules is shared by both NCUA and the Federal Trade Commission. Other agencies also issue rules that protect consumers in financial transactions. Notable examples are in the area of privacy and fair credit reporting. These are often joint rulemaking efforts by all of the financial institution regulators, including NCUA. Significant exceptions include the rules issued under the Real Estate Settlement Procedures Act, which imposes disclosure and other requirements for mortgage lending and are implemented by the Department of Housing and Urban Development. Much of the impetus for consolidating consumer protection regulation in a single agency comes from the desire to stop certain financial institutions from making ``unsafe'' products available to unwitting consumers. Credit unions do not have much history of selling unsafe products to their members, although there can be healthy debates about whether some products, such as overdraft protection and payday-loan equivalents, are good for consumers or not. Sometimes the same product can be pro- or anti-consumer, depending on its terms and on how it is serviced. Since the managers of firms tend to serve the interests of owners, and credit unions are owned by their members who are represented by democratically elected boards with authority over managers, consumers do not typically need much protection from their credit unions. However, inadvertent errors can occur, and comparative disclosures are important. Although we certainly see the appeal in creating a separate agency that would issue and implement consumer protection rules as this would centralize this important function, we would want to make sure that there is no net increase in the regulatory burden imposed on credit unions. Since we have not contributed to the problem, we would like not to pay a big price for the answer to a question that barely exists in our industry. In particular, enforcement and examination should remain primarily in the hands of NCUA; unleashing a new army of enforcers and examiners would add little to consumer well-being except costs, in the case of credit unions. However, we would be concerned that shifting rulemaking power from NCUA to a separate agency would curtail NCUA's authority. NCUA has had responsibility in implementing many consumer protection rules, often as a joint effort with other agencies. We believe that the creation of a separate agency should not limit NCUA's ability to continue to provide input and ensure that new rules address specific credit union concerns. We would also be concerned with any changes that would limit NCUA's current enforcement authority in this area.History Teaches Lessons About Supervision of Credit Unions Although the first credit unions in the United States were state-chartered credit unions established in New Hampshire and Massachusetts around 1909--we will be celebrating the centenary of U.S. credit unions in Boston later this year--federal regulation of credit unions did not begin until 1934. That year, at the height of the Great Depression, Congress passed the Federal Credit Union Act and created the federal credit union charter. (Federal deposit insurance--or, as we call it, share insurance--for federal- and state-chartered credit unions did not come into being until 1970.) Congress created the federal credit union charter in large part because the financially troubled banks of the time were not able to meet the public demand for consumer and small business credit. The troubles of those times were not so different from our current problems. Foreclosures abounded. Banks--many of which had significant numbers of uncollectible loans on their books, as well as other bad assets--were unable or unwilling to extend necessary credit. Not-for-profit credit unions were encouraged to step up and do what for-profit banks could or would not do. The passage of the Federal Credit Union Act marked the beginning of a long period in which federal credit union regulation was something of a wandering orphan. The first stop, from 1934 to 1942, was at the Farm Credit Administration, perhaps because the Farm Credit Administration regulated Farm Credit System cooperatives rather than for-profit banks. While the relationship between credit unions and the Farm Credit Administration was initially good, by the late 1930s many Farm Credit Administration officials had become indifferent or openly hostile to credit unions since the agency was overburdened and federal credit union supervision had no real connection to the Farm Credit Administration's basic functions. The second stop, beginning in 1942, was the FDIC. There, the hazards of being regulated by an agency primarily dedicated to the banking industry soon became apparent. Only weeks after federal credit unions came under FDIC supervision, then-CUNA President R.A. West said ``we are very much of an orphan in the [FDIC] and . . . steps must be taken to relieve this situation as quickly as possible.'' In various statements, the FDIC denigrated the importance of credit unions, urged Congress to give them low priority, and dismissed the importance of credit unions in the FDIC's own work. By 1947, it was clear that federal credit unions needed a regulator of their own in order to prosper, and CUNA began to seek such an arrangement. That wish was partially fulfilled when Congress created the Bureau of Federal Credit Unions in 1948. The Bureau wandered between the now-dissolved Federal Security Agency and the Department of Health, Education and Welfare before evolving into the completely independent NCUA we know today. Admittedly, federal credit unions' experience with regulation by FDIC and other multi-jurisdictional agencies occurred decades ago, but Congress has wisely not repeated the mistake of having credit unions supervised at the federal level by a bank regulator or another multi-jurisdictional agency. As discussed earlier in this statement, anti-credit union bias periodically manifests itself today within federal banking regulatory agencies. History teaches that credit union regulation should not be entrusted to a multifunctional regulator, and especially not one whose primary constituency is the banking industry.Conclusion Mr. Chairman, thank you again for the opportunity to testify on this important issue. The issues you are examining are important. Once they are settled, we believe it will be appropriate for Congress to take a hard look at some other long-postponed issues, such as whether the current powers of credit unions are sufficient to serve their members, or whether they have been limited for the benefit of the banking industry. Meanwhile, we urge Congress to maintain the independent federal regulator for credit unions not only for the well-being of credit unions, but also for the well-being of the 92 million consumers who benefit from credit union membership. ______ CHRG-111shrg50564--34 Mr. Volcker," Well, I do not think I am going to get into that question this afternoon. I do think that conditions in financial markets which were related to the large balance of payments deficit, large current account deficit, and the free flow of money from abroad laid the groundwork for many of the excesses in the market. Senator Shelby. Now, this is in your report, as I understand it. One of the key recommendations of the G-30 Report is creating a failure resolution regime that imposes discipline--that is, actual losses--not only on managers and shareholders but also on sophisticated creditors. I believe one of the primary failings of the recent bailouts of the GSEs, AIG, and Bear Stearns was the intent of protecting any creditors from losses. Dr. Volcker, in terms of who qualifies as a ``sophisticated creditor,'' do you believe that both financial institutions such as investment banks and foreign central banks would count as sophisticated creditors? Or should? " FinancialCrisisReport--373 In May 2006, Magnetar created its first CDO, Orion 2006-1 Ltd., a $1.3 billion hybrid CDO with cash and synthetic assets. 1497 The CDO closed on May 26, 2006, and was underwritten by Calyon and managed by NIBC Credit Management, Inc. 1498 Deutsche Bank’s Special Situations Group purchased equity in Orion, and helped create the CDO. 1499 A Deutsche Bank employee, Michael Henriques, who worked on Orion as managing director of the Special Situations Group, left Deutsche Bank and ultimately went to work for Magnetar. 1500 Although Orion received investment grade ratings from Fitch and Moody’s in June 2006, 1501 a little over a year later, on August 21, 2007, Fitch issued the first of several rating downgrades. 1502 In November 2007, Moody’s downgraded the Class A notes six notches and the Class B notes seven notches. 1503 By May 2008, every class of Orion’s securities had been downgraded to junk status. 1504 START CDOs. Deutsche Bank also underwrote six START CDOs with a combined value of $5.25 billion from June 2005 to December 2006. 1505 In one of the deals, Deutsche Bank worked with Elliot Advisors, a hedge fund that bought the equity tranche in the CDO and 1496 8/23/2006 email from Jeremy Coon at Passport Management to Greg Lippmann, DBSI_PSI_EMAIL01603121. In another email, when asked how Magnetar distorted the market, Mr. Lippmann responded, “easy but lengthy answer get him on the phone and call me.” 8/31/2006 email from Warren Dowd at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL01641089. 1497 See Loreley Financing v. Credit Agricole Corporate and Investment Bank , (N.Y. Sup.), (10/29/2010). Orion 2006-1 is one of two Magnetar CDOs that are the subjects of this lawsuit filed by Loreley Financing, a European- based investment fund, and Crédit Agricole, a French bank. See also “Magnetar Deals at Center of New Lawsuit,” ProPublica (10/25/2010), http://www.propublica.org/article/magnetar-deals-at-center-of-new-lawsuit. 1498 See Loreley Financing v. Credit Agricole Corporate and Investment Bank , (N.Y, Sup.), (10/29/2010) (alleging Calyon permitted Magnetar to select poor assets for the two Magnetar CDOs and fraudulently induced investors to purchase the securities). 1499 “Magnetar Gets Started,” ProPublica (4/9/2010), http://www.propublica.org/article/magnetar-gets-started; Loreley Financing v. Credit Agricole Corporate and Investment Bank , (N.Y. Sup.), (10/29/2010). 1500 Loreley Financing v. Credit Agricole Corporate and Investment Bank , (N.Y. Sup.), (10/29/2010). 1501 “Fitch Rates Orion 2006-1, Ltd./LLC.,” BusinessWire (5/26/2006), http://www.thefreelibrary.com/Fitch+Rates+Orion+2006-1,+Ltd.%2FLLC.-a0146274727; 6/9/2006 “$292.5 Million of Debt Securities Rated, $936 Million of Senior Credit Swap Risk Rated,” Moody’s, http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_109282. 1502 Fitch downgraded the CDO’s Class A notes from AAA to AA, the Class B notes from AA to A-, the Class C notes from A to BB, and the Class D notes from BBB to B+. “Fitch Downgrades $289MM of Orion 2006-1, Ltd.,” BusinessWire (8/21/2007), http://www.highbeam.com/doc/1G1-167859601.html. 1503 11/1/2007 “Moody’s takes neg action on Orion 2006-1,” Moody’s, http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_143474. 1504 10/28/2010 “Moody’s lowers ratings of 95 Notes issued by 56 structured finance CDO transactions,” Moody’s, http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_208444. 1505 They included Static Residential 2005-A for $1 billion; Static Residential 2005-B for $1 billion; Static Residential 2005-C for $500 million; Static Residential 2006-A for $1 billion; Static Residential 2006-B for $1 billion; and Static Residential 2006-C for $750 million. Chart, ABS CDOs Issued by DBSI (between 2004 and 2008), PSI-Deutsche_Bank-02-0005-23. simultaneously bought CDS protection against the entire structure, essentially shorting the deal and betting that the value of its assets would fall. 1506 On four of the deals, Deutsche Bank worked with Paulson Advisors, a hedge fund that bought the equity tranche and apparently shorted the rest of the CDO, while Deutsche Bank sold the rest of the securities. 1507 An internal FinancialCrisisReport--165 B. Background At the time of its collapse, Washington Mutual Savings Bank was a federally chartered thrift with over $188 billion in federal insured deposits. Its primary federal regulator was OTS. Due to its status as an insured depository institution, it was also overseen by the FDIC. (1) Office of Thrift Supervision The Office of Thrift Supervision was created in 1989, in response to the savings and loan crisis, to charter and regulate the thrift industry. 597 Thrifts are required by their charters to hold most of their assets in mortgage lending, and have traditionally focused on the issuance of home loans. 598 OTS was part of the U.S. Department of the Treasury and headed by a presidentially appointed director. Like other bank regulators, OTS was charged with ensuring the safety and soundness of the financial institutions it oversaw. Its operations were funded through semiannual fees assessed on the institutions it regulated, with the fee amount based on the size, condition, and complexity of each institution’s portfolio. Washington Mutual was the largest thrift overseen by OTS and, from 2003 to 2008, paid at least $30 million in fees annually to the agency, which comprised 12-15% of all OTS revenue. 599 597 Twenty years after its establishment, OTS was abolished by the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-203, (Dodd-Frank Act) which has transferred the agency’s responsibilities to the Office of the Comptroller of the Currency (OCC), and directed the agency to cease all operations by 2012. This Report focuses on OTS during the time period 2004 through 2008. 598 6/19/2002 OTS Regulatory Bulletin, “Thrift Activities Regulatory Handbook Update” (some educational loans, SBLs, and credit card loans also count towards qualifying as a thrift), http://files.ots.treas.gov/74081.pdf. 599 See April 16, 2010 Subcommittee Hearing at 11 (testimony of Treasury IG Eric Thorson). FOMC20080109confcall--16 14,MR. STOCKTON.," I believe in nonlinear dynamics. [Laughter] I think I have even experienced them, and probably you have as well on occasion, in terms of the difficulty that we have in forecasting recessions. Our forecast isn't just some sort of ""push a button on a linear model and here is the result."" But I do think the current situation illustrates to me why it is, in fact, so hard for us and why we don't forecast recessions very often. As I indicated, I think there is a configuration of a number of indicators that make it easy for me to imagine you looking back on next June and saying, ""Indeed, what you saw back there in December--in terms of the jump in the unemployment rate, the drop in the manufacturing ISM, and the uptick in initial claims-- were all precursors of a recession."" The point of my remarks is that I am pretty darn worried about that possibility. But it is hard at this point to make that call--we are coming off the data in the fourth quarter, which have exceeded our expectations considerably. As I noted, not all the things that you might expect to be highly sensitive to a business cycle downturn, such as motor vehicle sales, have moved in that direction. I know this is unfortunate, and we really cannot be as helpful to you as I would like. We are saying, in effect, ""Yes, we'll call the recession when we see the weak spending data."" But the weak spending data will already be lagged one or two months, and that is the reason that we will be looking back, if we're lucky to be able to do it in March, saying, ""The spending data indicate that a recession may have started in December."" The current forecast is our best judgment. But I think it wouldn't take much more in the way of negative news for us at this point to regime-shift, as you said, into recession mode. We are not quite there yet, but we are certainly worried about that possibility at this point. " CHRG-110hhrg44901--143 Mr. Bernanke," That was a very difficult episode for Japan when the bubbles in both the stock market and in property prices collapsed at the same time. I think the key lesson that we learned from that experience was that in Japan, banks had very wide holdings in land and equity and other assets whose values came down, and so the banks were in very, very bad financial condition, but they were not required to disclose or inform the public about what their actual condition was. For many, many years they kind of limped along. The same with the companies they lent to. They didn't call those loans because they knew they couldn't be paid. So it was a situation in which there was a reluctance to act and in which transparency was quite limited. I think one benefit of our current system here in the United States is that as painful as it is to see the losses that financial institutions are suffering, at least they are getting that out, they are providing that information to the public, and they have been proactive in raising capital to replace those losses. In order to avoid a prolonged stagnation, as in Japan, it is important for us to get through this period of loss and readjustment and get back to a point where the financial system can again support good, strong, stable growth for the United States. " fcic_final_report_full--330 Paulson told the FCIC that although he learned of the Fed and OCC findings by Au- gust , it took him three weeks to convince Lockhart and FHFA that there was a cap- ital shortfall, that the GSEs were not viable, and that they should be placed under government control.  On August , FHFA informed both Mudd and Syron that their firms were “adequately capitalized” under the regulations, a judgment based on finan- cial information that was “certified and represented as true and correct by [GSE] man- agement.” But FHFA also emphasized that it was “seriously concerned about the current level of Fannie Mae’s capital” if the housing market decline continued.  Fannie’s prospects for increasing capital grew gloomier. Fannie informed Treasury on August —and repeatedly told FHFA—that raising capital was infeasible and that the company was expecting additional losses. Even Fannie’s “base-case earnings forecast” pointed to substantial pressure on solvency, and a “stressed” forecast indi- cated that “capital resources will continue to decline.”  By September , Lockhart and FHFA agreed with Treasury that the GSEs needed to be placed into conservatorship. That day, Syron and Mudd received blistering midyear reviews from FHFA. The opening paragraph of each letter informed the CEOs that their companies had been downgraded to “critical concerns,” and that “the critical unsafe and unsound practices and conditions that gave rise to the Enterprise’s existing condition, the deterioration in overall asset quality and significant earnings losses experienced through June , as well as forecasted future losses, likely re- quire recapitalization of the Enterprise.”  A bad situation was expected to worsen. The -page report sent to Fannie identified sweeping concerns, including fail- ures by the board and senior management, a significant drop in the quality of mort- gages and securities owned or guaranteed by the GSE, insufficient reserves, the almost exclusive reliance on short-term funding, and the inability to raise additional capital. FHFA admonished management and the board for their “imprudent deci- sions” to “purchase or guarantee higher risk mortgage products.” The letter faulted Fannie for purchasing high-risk loans to “increase market share, raise revenue and meet housing goals,” and for attempting to increase market share by competing with Wall Street firms that purchased lower-quality securities. FHFA, noting “a conflict between prudent credit risk management and corporate business objectives,” found that these purchases of higher-risk loans were predicated on the relaxing of under- writing and eligibility standards. Using models that underestimated this risk, the GSE then charged fees even lower than what its own deficient models suggested were appropriate. FHFA determined that these lower fees were charged because “fo- cus was improperly placed on market share and competing with Wall Street and [Freddie Mac].”  CHRG-111hhrg58044--374 Mr. Rukavina," It is my understanding that collection accounts go into the credit history portion of a credit score and that following a hearing before this subcommittee, it was clarified that medical accounts in collection are used as a factor in determining credit scores. What is confusing to me as a consumer and wearing my policy hat is why medical accounts are treated differently based on who furnishes the data to the consumer reporting agencies. I am curious as to whether other data are treated in a similar fashion, depending on who furnishes it. " CHRG-111hhrg58044--376 Mr. Rukavina," We have talked with people from the lending industry who have been confused by the credit scores of individuals, that they feel are quite good credit risks, and when they look at the credit report, find there are oftentimes several either zero balance medical accounts that are in collection or medical accounts that have a very small balance in collection. This to us, based on our experience, indicates oftentimes not a problem in terms of credit, but a problem regarding the health care billing system and frankly, the insurance adjudication process. These bills are then sent to collection and we have been told by some in the collection industry that a significant number of people whom they contact pay off those bills promptly. We believe they are doing the right thing by paying their bills, which is advised by those in the credit scoring industry, that is something people should do. We believe they are doing that. In spite of those bills having a zero balance, they continue to drag down people's credit scores. We have worked with some in the industry who have run people's credit history through a credit score simulator and have found that by removing medical trade lines in collection, people's credit scores have increased by 50 to 100 points. These are for medical accounts that have a zero balance due. Ms. Kilroy. Would you agree that hurting people's credit scores with paid medical debt for the 7-year period could have an adverse effect on America's economic recovery and people's ability to get a loan, buy a car, buy a house? " FOMC20080625meeting--298 296,MR. EVANS.," Thank you, Mr. Chairman. I will also try to be brief, in spite of the large number of questions that were handed out. The short term should be quite easy. On the tactical issues, I agree with the suggestion of extending the facilities through year-end. They seem to have worked well. Also, a number of very interesting and important initiatives are ongoing as well on the CDS over-the-counter market and tri-party repo, and those should help out as well. On the longer-term issues, I am very happy to hear that you will be giving a speech and testimony on this, and I will be looking forward to how you lay out those issues. Obviously, there are large-scale changes in our regulatory environment that are being contemplated. These happen only every now and then. It is an opportunity to improve or to make a tremendous mistake if we are not very careful. So I think it, obviously, requires a tremendous amount of time. People have talked about the various issues, so I won't dwell on them. I think there have been a lot of very good comments around the table and speeches that have laid out the important issues that we are facing. One that I am sure we will have to talk a bit more about is that we can't think about this in a static environment. Obviously, the markets are very dynamic. As soon as we lay out a structure that will help out certain types of institutions, then there is going to be an opportunity to arbitrage that. We are presumably talking about reducing earnings of a number of institutions, and so they will be seeking those out. Another way to characterize the big question--it is nothing new--is how we maintain the incentives for market discipline. Many of the comments that President Stern and others made about how we think about preparing for possible resolutions will be very important. So I am looking forward to many more discussions about this. Thank you. " FOMC20081007confcall--23 21,MR. SHEETS.," Since the last Greenbook, the economic indicators for the foreign economies have generally surprised us on the downside, notwithstanding the fact that our expectations in the Greenbook for foreign growth were already pretty grim. In the euro area, measures of consumer and business sentiment have continued to retreat. Industrial production has moved down, and retail sales have been soft. Recent data for the United Kingdom have continued to point to a mild contraction during the second half of this year, and notably house prices there continue to fall. In Japan, industrial production plummeted in August, recording its biggest monthly decline in more than five years, and survey data point to further declines in business and consumer confidence. Finally, in the emerging market economies, industrial production has fallen in a broad set of countries, and exports have softened significantly. In light of these data, we now see foreign growth in the second half of this year as likely to come in at a little less than 1� percent, down � percentage point from our last forecast, with these markdowns spread about evenly between the advanced economies and the emerging market economies. We have reduced our projections for growth in 2009 almost as much. This weakening outlook for global activity has been largely driven, as Bill has described, by a marked deterioration in financial conditions in both the advanced and the emerging market economies. Since the last FOMC meeting, equity markets have fallen sharply in numerous countries. Risk premiums on many types of assets have risen, and conditions in short-term funding markets have worsened further. These difficult financial conditions threaten the outlook for foreign growth going forward both by weighing on sentiment in financial markets and by potentially limiting the flow of credit to the economy. If there is any good news for me to report, it's that the softening outlook for global growth has continued to put downward pressure on the price of oil and other commodities. Oil prices have been extraordinarily volatile over the last month, lurching up and down in response to a number of factors, including the effects of the two hurricanes, shifting expectations regarding global growth, and financial turbulence. On net, as Larry mentioned, the price of WTI is down about $13 a barrel since the Greenbook and down over $55 per barrel from its peak in mid-July. Prices for many nonfuel commodities have fallen sharply since the FOMC meeting, including price declines of more than 10 percent for copper, nickel, and rubber, and more than 20 percent for corn and soybeans. Headline inflation remains elevated in the advanced foreign economies. Notably, U.K. inflation in August reached 4� percent, a 15-year high. In contrast, the most recent CPI data for the euro area hint at some deceleration, with inflation moving down from over 4 percent in July to 3.6 percent in September. Going forward, there are good reasons to expect inflation in these economies to abate, given the recent sharp decline in commodity prices and emerging slack in their economies. Inflation rates in the emerging market economies appear to be cresting for similar reasons. In the midst of these events, the dollar has remained quite resilient, rising about 3 percent since the last FOMC meeting. In our view the currency markets earlier this year had priced in expectations that the major foreign economies would remain largely resilient despite U.S. slowing. As the growth prospects for the foreign economies have deteriorated, the relative attractiveness of the dollar has increased. This, along with the sustained demand for dollar funding in global financial markets, seems to have buoyed the dollar of late. Finally, given the weaker path of foreign activity and the stronger dollar, we now expect export growth to be somewhat less robust than was the case in our previous forecast and, consequently, net exports to be less supportive of U.S. economic growth over the next two years. Nevertheless, net exports are still expected to contribute a positive 0.5 percentage point to growth in the second half of this year and about 0.3 percentage point in 2009. We are happy to take your questions now. " CHRG-111hhrg58044--387 Mr. Cohen," Thank you, sir. I got an answer and I have heard it before. You do not have any data to discredit Mr. Rosenberg, and Mr. Rosenberg does not have anything to support any reports or any information to support the credit reports. We are kind of going in a circle, kind of a Catch-22, just like the persons-- " FinancialCrisisReport--245 Looking back after the first shock of the crisis, one Moody’s managing director offered this critical self analysis: “[W] hy didn’t we envision that credit would tighten after being loose, and housing prices would fall after rising, after all most economic events are cyclical and bubbles inevitably burst. Combined, these errors make us look either incompetent at credit analysis, or like we sold our soul to the devil for revenue, or a little bit of both.” 955 A. Subcommittee Investigation and Findings of Fact For more than one year, the Subcommittee conducted an in-depth investigation of the role of credit rating agencies in the financial crisis, using as case histories Moody’s and S&P. The Subcommittee subpoenaed and reviewed hundreds of thousands of documents from both companies including reports, analyses, memoranda, correspondence, and email, as well as documents from a number of financial institutions that obtained ratings for RMBS and CDO securities. The Subcommittee also collected and reviewed documents from the SEC and reports produced by academics and government agencies on credit rating issues. In addition, the Subcommittee conducted nearly two dozen interviews with current and former Moody’s and S&P executives, managers, and analysts, and consulted with credit rating experts from the SEC, Federal Reserve, academia, and industry. On April 23, 2010, the Subcommittee held a hearing and released 100 hearing exhibits. 956 In connection with the hearing, the Subcommittee released a joint memorandum from Chairman Levin and Ranking Member Coburn summarizing the investigation into the credit rating agencies and the problems with the credit ratings assigned to RMBS and CDO securities. The memorandum contained joint findings regarding the role of the credit rating agencies in the Moody’s and S&P case histories, which this Report reaffirms. The findings of fact are as follows. 1. Inaccurate Rating Models. From 2004 to 2007, Moody’s and S&P used credit rating models with data that was inadequate to predict how high risk residential mortgages, such as subprime, interest only, and option adjustable rate mortgages, would perform. 2. Competitive Pressures. Competitive pressures, including the drive for market share and need to accommodate investment bankers bringing in business, affected the credit ratings issued by Moody’s and S&P. 3. Failure to Re-evaluate. By 2006, Moody’s and S&P knew their ratings of RMBS and CDOs were inaccurate, revised their rating models to produce more accurate ratings, but then failed to use the revised model to re-evaluate existing RMBS and 955 9/2007 anonymous Moody’s Managing Director after a Moody’s Town Hall meeting on the financial crisis, at 763, Hearing Exhibit 4/23-98. 956 “Wall Street and the Financial Crisis: The Role of Credit Rating Agencies,” before the U.S. Senate Permanent Subcommittee on Investigations, S.Hrg. 11-673 (4/23/2010) (hereinafter “April 23, 2010 Subcommittee Hearing”). FinancialCrisisInquiry--216 I think that’s probably right. And I’d say 4 million people who became homeowners probably shouldn’t have become homeowners. We put them in a situation which wasn’t really tenable. HOLTZ-EAKIN: And in the fallout from that, we had a large financial crisis. And, Mark, I know you’ve thought a lot about this. From the fall of 2008 going forward, we’ve had a series of interventions—the Capital Purchase Programs, we did stress tests, we had suspension of mark-to-market rules—and, I guess, I want your opinion, out of the array of the financial market interventions, which do you think are deservedly credited with the turnaround we’ve seen to date—I don’t want to overstate it—and which do you put on a lower rung? ZANDI: I think the Capital Purchase Program was a necessary condition for stabilizing the financial system. I don’t think the system would have stabilized without that injection of capital at that point in time, so I think that was absolutely vital. I think the thing that really ended the—the panic once and for all were the stress tests. I think they were incredibly therapeutic, to my surprise. I—I did not expect them to go as well as they did. And, in fact, I think that is a very therapeutic process to be adopted going forward. We do a lot of risk modeling. We try to incorporate economic information into the risk processes, the financial institutions, something we’ve done in the—in the wake of the crisis. And it is to my great surprise that these institutions did not have any systematic way of stressing their portfolios. And actually some of the larger institutions—interestingly enough, they are quite sophisticated, but they’re very siloed. So the credit card folks would do it one way; the mortgage guys would do it another way; the corporate bond— the corporate lending folks another. There was no sort of across the entire balance sheet. And this stress test process for the 19 bank-holding companies was, in fact, that, and it was, I thought, very well done and ultimately restored confidence in the system and is where we are today. Now, the one part of the system that’s not working and the system will not work well without it is the process of securitization. Ironically, that’s what got us—the flawed securitization process goes to your point. That’s how we got that homeownership rate up. That’s how we got all those bad loans being made. And $2 trillion in private bond issuance in 2006 at the height of the... FOMC20081216meeting--232 230,MR. KOHN.," I am not going to even try to top either of those anecdotes or jokes. I agree certainly with the thrust of the comments around the room. The economy is in a steep decline. There was a break in confidence somewhere in September that took what had been a gradual decline in employment, production, and output and made it much, much, much, much steeper. The feedback loop between the financial markets and the real economy just intensified--turned up many, many notches at that time. Households and businesses, as President Fisher was remarking, are very worried, and they are acting in a way to protect themselves. They have cut back on spending, and they have cut back on lending. I think the response of businesses is particularly interesting. They responded very, very rapidly to the falloff in demand with cuts in employment and production. So we are not even getting the sort of automatic stabilizer effect that we usually get from a buildup in inventories and a bit of labor hoarding as demand drops. Thus businesses' actions are just accentuating the weakness. As many have remarked, the weakness is global, everywhere, including in emergingmarket economies where, as Shaghil showed us, the inflow of capital has slowed substantially. There is no real region to lead the globe out of this swamp we are in. Financial markets remain very strained. I think of particular concern are the securitization markets. When they are not operating, a lot of credit to households and businesses won't be available at the same time that the banks are tightening up very sharply. We have seen in these charts that household and business borrowers with anything less than very high credit scores are just finding credit either extraordinarily expensive or unavailable. As a consequence, a very sizable output gap has opened up. I think we can see that the decline is going to remain steep for some time. The multiplier�accelerator effects of the drop in demand we have seen over the last couple of months have to feed back through consumption and investment. I don't think we have seen the full effect of the tightening in credit conditions and the decline in wealth from the end of September on. You can see the continuing economic decline in the initial claims data, the weekly IP, and the anecdotes we heard around the table on sales; and financial markets are going to remain impaired for a while despite our best efforts to open them up. There are huge losses in the capital of intermediaries to absorb, so folks will be very cautious about making loans. As long as investors, savers, households, and businesses see the economy in steep decline, the fear that is gripping the financial markets and the economy isn't going to abate very rapidly. Inflation is decelerating across a broad front, and that is going to continue. Economic slack will be increasing, cost pressures will be abating, and the ability to pass through cost increases will be highly constrained. So far, longer-term inflation expectations seem to have been reasonably well anchored, though they are very hard to measure. But I agree with President Bullard that we are going to need to watch this very, very closely for signs of a disinflationary dynamic taking hold. I think what happens to the economy and inflation over the latter part of next year is extremely uncertain. We have huge changes in forecasts in very short periods of time, and I suspect, like the staff, that the improvement in financial markets and the rebound in the economy will be gradual, in part reflecting the limited power of monetary policy. But even if we thought that a sharper rebound next year was a distinct possibility, I don't think it would matter very much for our policy purposes here today. The trajectory, the economic decline, the extent of the output gap, and the degree of disinflation in train all imply that our task at this time is to try to limit economic weakness. Thank you, Mr. Chairman. " FOMC20070807meeting--116 114,MR. LACKER.," Thank you, Mr. Chairman. I think we have a couple of issues in front of us today. First, do we react to the recent inflation numbers? I have been pleased by the recent reports, as I said, coming in better than expected, but there seems to be a substantial chance that the improvement we have seen is temporary and that we will get some higher figures later this year. Moreover, inflation expectations remain above where I’d like them to be, so I don’t think we should relax our characterization of inflation in this statement. A second question we face is how to react to the recent turmoil in financial markets. I think we need to be careful to maintain our focus on the implications of market developments for the anticipated paths of inflation and real spending. At this point, I don’t see those implications being substantial enough to warrant a policy response on our part or a change in our sense of the likely near-term policy path, though obviously this assessment may change as events unfold. Absent evidence of such implications, our financial stability responsibilities can be met quite adequately through the automatic supply of reserves under the Desk’s operating procedures for targeting the overnight federal funds rate or through the supply of reserves to solvent institutions at the discount window. Unfortunately, the recent behavior of the fed funds futures market and recent financial press commentary suggest that some market participants, perhaps thinking back to 1987 or 1998, believe that financial market turbulence per se will induce us to respond with interest rate cuts. Even if we did cut rates to counter financial market volatility, financial market jitters might take some time to dissipate. We may be reluctant to undo such rate cuts in the meantime, and we would run the risk that policy then becomes too easy and we get behind the curve. My main concern is the risk that our communication today might mislead markets into thinking that we may cut rates in response to asset-price volatility per se, absent any expectation of sustained effects on the real economy or inflation. Accordingly, I believe the statement language should acknowledge the recent developments as in the second part of alternative B but not go any further. I’m concerned about paragraph 4 and adding the passage about downside risks to growth increasing. I’m concerned that it may go a bit too far in that direction. I think that the minutes should acknowledge the problems in subprime and private equity markets, and I also think the minutes should educate financial markets that the mitigation of volatility in asset prices is not an FOMC objective. Thank you." CHRG-111hhrg67816--152 Mr. Green," That is what I was going to say. There may be things that the consumer may not--that is not on that report that is being used for their credit rating. " CHRG-111shrg51395--93 Mr. Coffee," I am glad you asked that question because it is a good question, but there are two major limitations on Rule 10b-5. As you have heard from others on this panel, it does not apply to aiders and abetters, even those who are conscious co-conspirators in a fraud. That is one limitation that Congress can address. And, two, when you try to apply Rule 10b-5 to the gatekeepers, whether it is the accountants or the credit rating agencies, you run up against the need to prove scienter. It is possible to have been stupid and dumb rather than stupid and fraudulent, and that is basically the defense of accountants and credit rating agencies. I think you need to look to a standard of scienter that will at least create some threat of liability when you write an incredibly dumb AAA credit report on securities that you have not even investigated, because you do not do investigations as a credit rating agency. You just assume with the facts that you are given by management. So I do think there is some need for updating the anti-fraud rules for the reasons I just specified. Senator Reed. Thank you. " FOMC20080625meeting--41 39,MR. SHEETS.," Yes. The spike that we have seen is driven particularly by commodity prices. The depreciation of the dollar has played a secondary role, so the decline in core import price inflation to below 2 percent next year is conditioned crucially on commodity prices flattening out and the dollar not depreciating as rapidly as it has over the past few years. " CHRG-111shrg53176--166 RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM MARY L. SCHAPIROQ.1. Business Development Companies (BDCs), which are regulated under the Investment Company Act, support more than 10,000 jobs in my home State of New Jersey through their extension of credit and investments in more than 20 small and middle-market companies. I understand that the BDC industry has largely ceased to extend credit due to certain Investment Company Act rules that, in the current market environment, may be having unintended consequences. Does the Commission intend to address this problem, and if so, could the Committee expect to receive a report on the Commission's actions?A.1. Over the past year, the greatest challenges to BDCs have resulted from market conditions rather than regulatory restrictions. The dearth of available credit, with the general decline in the value of financial assets, has severely limited the ability of BDCs to raise new capital to invest in small and middle-market companies. During the year ending on March 31, 2009, the net asset value (``NAV'') of the four largest BDCs declined an average of 32.5 percent. Declines in the market value of the shares of these BDCs were more severe, and shares of all four BDCs trade at significant discounts to NAV. The two largest BDCs are in default under their loan agreements, and their auditors have raised going concern issues. As detailed below, the staff generally believes that the regulatory requirements for BDCs are operating as intended. The staff also generally believes that improvements in the availability of credit and in the market values of assets held by BDCs are far more likely to enable BDCs to raise additional capital, and extend credit to small and middle-market companies, than regulatory relief.The Relevant Regulatory Requirement for BDCs Under the Investment Company Act of 1940 (``Act'') BDCs are a type of closed-end investment company regulated under the Act. The Act's capital structure requirements limit the ability of a BDC to raise additional capital by issuing preferred stock or incurring debt. Specifically, the Act prohibits a BDC from issuing or selling preferred stock or incurring debt (or declaring cash dividends on its common stock or repurchasing its common stock), unless immediately thereafter the BDC has asset coverage of its preferred stock plus debt securities of at least 200 percent. These requirements are more permissive than the Act's requirements for other closed-end investment companies whose debt securities must have asset coverage of at least 300 percent. In addition, a BDC may issue multiple classes of debt securities, but other closed-end investment companies may issue only one class of debt security. The Act's asset coverage requirement for BDCs exists for the protection of both investors in common stock on one hand and investors in debt securities or preferred stock on the other hand. As the percentage of a BDC's capital from preferred stock or debt increases, the risk to the common stockholders also increases. At the same time, the risk also increases that the BDC will lack the resources to pay promised interest or dividends or the principal or liquidation preference to the holders of the debt securities or preferred shares. In this regard, Section 1(b) of the Act states that the national interest is adversely affected ``when investment companies by excessive borrowing and the issuance of excessive amounts of senior securities [i.e., preferred stock or debt securities] increase unduly the speculative character of their junior securities [i.e., common stock]'' or ``fail to protect the preferences and privileges of the holders of their outstanding securities.'' Section 1(b) also states that the Act is to be interpreted ``to mitigate and, so far as is feasible, to eliminate the conditions enumerated in this section which adversely affect the national public interest and the interest of investors.''The Regulatory Requirement Generally Is Operating as Intended The Act does not prohibit a BDC from investing all of its available capital in portfolio companies. If a BDC fully invests its capital, a subsequent decline in the value of those investments that cause asset coverage to dip below 200 percent does not constitute a violation of the Act. (However, as explained above, the Act would prohibit the BDC from taking on additional leverage, declaring cash dividends on its common stock or repurchasing its common stock unless its asset coverage equals at least 200 percent at that time.) The Act's asset coverage requirement does not limit the ability of BDCs to raise capital by issuing additional common stock. In the past, some of the largest BDCs periodically issued shares priced at a premium to NAV. This additional equity capital, in turn, increased the BDCs' borrowing capacity. Under the Act, a BDC may issue additional shares priced at a discount to NAV, provided that the BDC's board makes certain findings and shareholders approve the offering. A number of BDCs have obtained board and shareholder authorization for such offerings. In fact, Prospect Capital Corporation, one of the ten largest BDCs, recently raised over $60 million in a public offering of its common stock priced below NAV. To the extent that BDCs have been interested in exploring relief from the Act's asset coverage requirement, the staff has given this issue serious and careful consideration in numerous meetings with BDC representatives, their accounting firms and their lawyers. The staff continues to engage in a dialogue with BDCs and their representatives about regulatory relief. In general, the staff believes that the Act's restriction on further leverage and payment of cash dividends on common shares or repurchase of common shares when asset coverage is less than 200 percent are generally working as intended. Nevertheless, the staff has provided no-action relief from the asset coverage requirement to the largest BDC so that it, and other BDCs in similar circumstances, could make cash dividend payments to the extent necessary to take advantage of IRS relief made available to certain closed-end investment companies earlier this year. The staff also agreed to permit BDCs to use the shelf registration process for sales of shares priced below NAV. Prospect Capital Corporation used a shelf registration for its recent sale of shares priced below NAV. We hope that this analysis constitutes the report contemplated by this question, but if Senator Menendez or the Committee requires additional information or updates, the staff would be pleased to provide it.Q.2. Does the Commission need any additional authority to address these problems, or are there legislative solutions that are necessary to make certain that credit continues to be made available to small and middle-market companies?A.2. The staff does not believe that additional authority would enhance the ability of BDCs to attract additional capital to invest in small and middle-market companies. If Congress were explicitly to authorize the Commission to suspend or eliminate all of the Act's capital structure requirements applicable to BDCs, the staff doubts that lenders would be more willing to extend credit to BDCs or the capital markets more willing to purchase shares issued by BDCs. ------ CHRG-110hhrg44900--217 Mr. Capuano," I don't mind, and it has nothing to do with the chairman. It got embroiled in some political chicanery and I got stuck. So I apologize. But I do want to ask--first of all I want to make it very, very clear that I support almost everything you have done and are discussing doing. Both of you I think are doing a great job. I think both of you are talking about the things you need to talk about. I think both of you are on the right path to where we need to go. I know how difficult it's going to be to get there. I know now controversial it is to some. I'm not so sure we are all going to agree on every detail, but that's not important. The concepts you are talking about, in my opinion, are exactly the right concepts that we should be talking about. I personally think we should have been talking about them years ago, but we will let that dog lie for a while, and we will just move forward. So I'm looking forward to getting us from where we are now to where we need to be. I do want to talk about a couple of specific items, though, that have been concerning me--especially relative to the Fed. I believe--I agree with the chairman--I believe that you have the authority to have done what you have done thus far. Under the unusual and exigent circumstances language, I believe that. I agree with what you have done; I think it's fine. However, it does raise serious questions. I think you know that. And I believe that moving forward, we will try to address those on a more permanent basis. My concern is in the meantime--you have seen this today, and I haven't seen the debate here today, but I have heard it a thousand times--there are a lot of people here that every time you hint at this much more oversight or regulation, they go absolutely berserk and somehow that's anti-American, and it's going kill the entire capitalist system, and the world will go to hell in a hand basket. I'm not like that; I believe that reasonable, fair, clear regulation actually helps the capitalistic society, and I think it's a good thing Between now and there, I'm deeply concerned of what we are going to do and what we have, and I am particularly concerned with the--it's not the amount, but the amount combined with what I see is the lack of requirements that the Fed is putting on those people who are coming to all the different windows that you have created. They are huge amounts of money. In the last 6 months, by my figures, the Fed has, all totalled, loaned out, give or take, over $3 trillion, which is more than 100 times more than you loaned out the previous 6 months. I'm not complaining about it. I think it's necessary. I think it's fine. I don't think it's unstable. I think it's the right way to go. But it's a huge amount of money. And almost all of that money has gone out with virtually, in my opinion, minimal at best, if any, requirements. I would argue--and I would ask your opinion--I would suggest that since you have the power to loan the money--you do not have the power, and I agree, to impose regulations on people before they get to the window--but I do believe that as a condition of the loan, you do have the ability to impose, not regulation but conditions of the loan that may look like regulations to some, that simply allows those people who come to the window to say, ``Hey, if I want the money, I will meet these requirements,'' whatever they might be. Capital requirements--and I trust your judgment as to what they might be; I know you would do it in conjunction with the Secretary and others--and I'm just curious, do you believe, do you agree or disagree that you currently have the authority, if you chose to use it, to put very clear, very concise conditions--not regulations, but conditions--on the loan that hopefully would lead us and my colleagues to know where you might want to go, if we gave you the authority--which I would be happy to do--if we gave you the authority to have those regulations before they got to the window? " CHRG-111shrg50814--4 STATEMENT OF SENATOR RICHARD C. SHELBY Senator Shelby. Thank you, Chairman Dodd. Chairman Bernanke, we welcome you back to the Committee. You have spent a lot of time with us. The economic and financial climate has deteriorated significantly since our last monetary policy hearing in July of 2008. In response to the Congress, the administration and the Federal Reserve have taken dramatic steps to navigate our way through this crisis. Since last summer, the Federal Reserve's balance sheet has more than doubled in size and presently stands at about $2 trillion. This expansion is a result of extraordinary actions taken by you and the members of the Board of Governors. Some of these actions were institution specific while others involved establishing new programs aimed at providing liquidity to the banking system and unfreezing credit markets. Because it would take too much of our time this morning to describe each action and program in detail, I will be brief and only discuss a few of them. I would, however, strongly encourage Chairman Dodd to conduct hearings on all of these programs. The Federal Reserve has provided assistance to several large financial entities, according to their words, ``in order to ensure financial market stability.'' Acting along with Treasury and the FDIC, the Federal Reserve has intervened to rescue Citigroup and Bank of America by providing a backstop for large pools of their loans. The Federal Reserve has extended the safety net beyond the banking system by establishing two new lending facilities in connection with the bailout of AIG. These facilities are winding down AIG's holdings and mortgage-backed securities and credit default swap contracts. The Federal Reserve will continue to run a virtual alphabet soup of liquidity facilities through April 30, 2009, at the least. In more recent months, the Federal Reserve announced initiatives aimed specifically at stabilizing our housing and securitization markets. The Fed has announced that it will purchase up to $100 billion in debt obligations of Fannie Mae, Freddie Mac, and Federal home loan banks, as well as up to $500 billion of mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Most recently, with securitization markets for all types of consumer credit virtually frozen, the Federal Reserve has announced the establishment of the Term Asset-backed Securities Loan Facility, or TALF. Under the TALF, the Federal Reserve Bank of New York will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated asset-backed securities backed by newly and recently originated consumer and small business loans. The New York Fed will lend an amount equal to the market value of the ABS less a haircut. The U.S. Treasury Department under the TARP will provide $20 billion of credit protection to the New York Fed in connection with the TALF. Given the scope of the Federal Reserve's recent actions, it seems unlikely that any future student will conclude that today's Federal Reserve was too timid in the face of this crisis, Mr. Chairman. Whether the Federal Reserve pursued the most effective actions will be another question, and that will also be the case for the efforts of the administration and the Congress, too. I hope that this Committee will use today's hearing to explore the effectiveness of the Federal Reserve's recent actions. One of the questions foremost in my mind, Mr. Chairman, is whether the Federal Reserve has thought about the long-term implications of its programs, its new programs. Chairman Bernanke, you have already begun discuss the need for an exit strategy, some of which will happen as credit conditions return to normal. Some of the new programs, however, have longer maturities. This presents a problem not only to you but for us. How do you decide when and how to remove the Federal Reserve from the market? This uncertainty may require the Fed to provide more clarity on when and how it will terminate these programs. In addition, Mr. Chairman, the Federal Reserve is likely to take more credit risk through the TALF than is customarily the case of its lending operations. This raises additional questions about transparency and what taxpayers should expect, and perhaps demand, from the Federal Reserve. Hopefully, Chairman Bernanke can begin to address these and other questions today. Thank you, Chairman. " CHRG-111shrg55278--93 PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD The economic crisis introduced a new term to our national vocabulary--systemic risk. It is the idea that in an interconnected global economy, it's easy for some people's problems to become everybody's problems. The failures that destroyed some of our Nation's most prestigious financial institutions also devastated the economic security of millions of working Americans who did nothing wrong--their jobs, homes, retirement security, gone in a flash because of Wall Street greed and regulatory neglect. After years of focusing on short term profits while ignoring long term risks, a number of companies, giants of the financial industry found themselves in serious trouble. Some failed. Some were sold under duress. And an untold number only survived because of Government intervention: loans, guarantees, and direct injections of capital. Taxpayers had no choice but to step in, assuming billions of dollars of risk, and save companies because our system wasn't set up to withstand their failure. These efforts saved our economy from catastrophe, but real damage remains. Investors, who lost billions, were scared to invest. Credit markets dried up. With no one willing to make loans, businesses couldn't make payroll, employees were laid off, and families couldn't get mortgages or loans to buy an automobile. Wall Street's failures have hit Main Streets across the country. It will take years, perhaps decades, to undo damage that a stronger regulatory system could have prevented. While many Americans understand why we had to take extraordinary measures this time, it doesn't mean they aren't angry. It doesn't mean they aren't worried. And it doesn't mean they don't expect us to fix the problems that allowed this to happen. First and foremost, we need somebody looking at the whole economy for the next big problem, with the authority to do something about it. The Administration has a bold proposal to modernize our financial regulatory system. It would give the Federal Reserve new authority to identify, regulate, and supervise all financial companies considered to be systemically important. It would establish a council of regulators to serve in a solely advisory role. And it would provide a framework for companies to fail, if they must fail, in a way that does not jeopardize the entire financial system. It's a thoughtful proposal. But the devil is in the details and I expect changes to be made. I share my colleagues' concerns about giving the Fed additional authority to regulate systemic risk. The Fed hasn't done a perfect job with the responsibilities it already has. This new authority could compromise the independence the Fed needs to carry out effective monetary policy. Additionally, systemic risk regulation involves too broad of a range of issues for any one regulator to oversee. And so, I am especially interested to hear from our witnesses your ideas on how we get this right. Many of you have suggested a council with real authority that would effectively use the combined knowledge of all of the regulatory agencies. As President Obama has said, when we rebuild our economy, we must ensure that its foundation rests on rock, not on sand. Today, we continue our work to lay the cornerstones for that foundation--strong, smart, effective regulation that protects working families without hindering growth. ______ FOMC20070321meeting--242 240,MR. FISHER.," Well, Mr. Chairman, I’ve given this a lot of thought. If you remember, in the last round I asked for a compelling argument for adopting a stated specific inflation target. I noted that it was not at all obvious that the countries that have adopted a specific inflation target have done better than we have in terms of economic performance over the past decade or, for that matter, better than countries that have not adopted a target. One could make the counterargument that it’s not at all obvious that countries that have adopted numerical definitions have done worse than we have. I understand and respect tremendously the theoretical arguments that can be made to validate adoption of a numerical inflation objective. However, to my mind our vulnerability is not with economists or even with what we used to call the “quant jocks” on Wall Street. Our vulnerability is with those to whom we are accountable—the people and the representatives of the people. Also, I’m not convinced that a numerical target is necessary at this stage. I do note that others have done this. I raised four children. One of my first instructions to my children was, “Just because everybody else is doing it doesn’t mean you have to do it.” I’m mindful of that today. [Laughter] I’m mindful of the fact that other countries have adopted this for different reasons. We know about the U.K.’s “Great Moderation.” I understand the use of a numerical target in terms of the ECB, given the complexity of many countries, non-uniform data, and a population base that keeps changing. I understand that the Bank of Japan had been so totally discredited that it was necessary to adopt such a target. I understand that the New Zealand government was so grossly incompetent that they had no choice but to adopt a target. I consider other countries a bit too small to be persuasive. We talked about one of them last time. So my real issue is that I can’t find a compelling case for or against, but I’m not of the nature that I like to join the crowd for the sake of joining the crowd. I don’t think it is a sufficient reason—and I can say this because I am the least academically prepared at this table—to do so at this time for the purity of what are very respectable theoretical arguments. I’m mindful of the politics. You and I have talked about this personally, Mr. Chairman. I am grateful for the comments that you made at the beginning of this discussion. Let me just state parenthetically that Barney Frank is one of the smartest men I know. He would actually understand that the word “stochastic” derives from the Greek “stochasticus,” which means “skillful in aiming,” and he probably knows more than any other congressman about this subject, even though he has drawn what appears to be a line in the sand. But that’s not what I’m worried about. I am worried about whether or not we’ve accumulated sufficient political capital to sell this to the rest of the Congress and to the representatives of the people, and I’m a little concerned about the timing of our doing so. We spent the past two days talking about downside risk to the economy. Some of us feel, as I stated in our earlier discussion, that we may be just a revision away or perhaps a shock away from some economic turbulence, some economic weakness, and perhaps a recession. I wonder about the optics, Mr. Chairman, of our dwelling on this subject at this time, given that there doesn’t seem to be a compelling need because we don’t have the same conditions that the United Kingdom, the ECB, the Bank of Japan, New Zealand, and others faced. Having said that—and I’m going to just shoot everything at once and then I’ll be done—I think it is implicit in question number 1 that we are going to adopt this, which I am not in favor of. But if I had a gun put to my head and someone said, “You must adopt this. What is your preferred index?” I would say, being someone who has an M.B.A. and not a Ph.D., that, first, it is important that we adopt whatever target we adopt such that businessmen, businesswomen, financiers, and other economic agents do not need to take inflation into consideration in their decisionmaking. Second, it must be politically palatable and credible and easy to understand. Ordinarily I would argue, if it weren’t for those two conditions, for what we love in Dallas, which is the trimmed mean; but that is way too complicated to explain to the public. But I would also argue against the PCE excluding energy and food. I would argue for adopting the CPI. I would argue for a 1 percent target over a three-year to five-year period. Over time they all converge at any rate. By the way, as far as I’m concerned, if my math is still correct, 1 percent means that prices double every 72 years, which is a reasonable lifetime, and given the ½ percentage point measurement bias, that might actually mean they double every 140 years, which is about as much as I would like to see. So I would argue for a 1 percent target based on the CPI—if you put a gun to my head, which I hope you don’t—over a longer time frame. As far as Committee participants arriving at a consensus view on this goal, I don’t think consensus is essential. In fact, you could have the Committee report a central tendency or some range. I’m not going to get into questions 5, 6, and 7. I want to go to the forecast narrative, which concerns me. As we’ve talked about before, I’m not in favor of full frontal views. I took note of Governor Kroszner’s comment about “kabuki” earlier; I think it’s good to preserve a little kabuki. If we are going to communicate with the public, we need to communicate in understandable language. I don’t wish to give offense, but I know I will—I would not be in favor of the staff drafting that statement. I would be in favor of writing it in the simplest possible language. I suggest, Mr. Chairman, that it would be more appropriate for, say, our communications staff or Michelle or somebody like that to draft this statement so that we communicate to the public in a way that is comprehensible. I was taken aback at even the use of the word “stochastic” at the end. We know what that means. The people have no idea what “stochastic” means. Again, I return to my root question. With whom are we trying to communicate? We talk about the markets. The markets are what—economists, theoretical economists, econometricians, ourselves, people on Wall Street, sophisticated operators of financial markets, businesswomen and businessmen, or the public in general? My greatest fear is doing anything that would impugn the integrity or threaten the preservation of this institution, and so I want to plead with you and with the rest of the people around this table: (1) to consider whether we really need to adopt an inflation target at this time and (2) should we do so, to make it as simple and comprehensible and easily communicated as possible and to do so in the same way with the forecast that we are discussing the possibility of issuing. Thank you, Mr. Chairman." CHRG-111shrg56376--42 Mr. Tarullo," Senator, I don't think there are any proposals on the table that would really make the Fed a systemic risk regulator in the sense of being able to swoop in anywhere, anytime, and say, we want to do something about this. The proposal that we have endorsed is making the Federal Reserve the consolidated supervisor of systemically important institutions. I would say in direct response to your question, there is certainly a responsibility there, and I would be the first to say that responsibilities of all the financial regulators, including the Fed, were not exercised as effectively as they ought to have been. But I would also say that when you give an entity responsibility, you do have to make sure that you give it authority to achieve that responsibility, to fulfill it, and that you have the mechanisms that will allow it to do the job. And when you have a circumstance in which large institutions that turned out to be systemically important--I think in some cases to the surprise of many--and were not within the perimeter of regulation, it was obviously not going to be an easy matter to contain the activities of those institutions, including a lot of the wholesale funding and a lot of the very tightly wound, complex securitization that was a major contributor to these problems. So I would say, first, you need to make sure that the appropriate legal authorities are present. Second, as I have often said, there needs to be a reorientation of our regulatory approach more generally toward systemic risk. And third, the Federal Reserve, I think, needs to take more advantage of the comparative abilities that it has. That is why we wanted to move forward, to make use of the economic and financial expertise to provide a monitoring of and a check upon the on-the-ground supervisors. That is where the advantages lie and that is where we ought to bring them together. Senator Corker. Let me just ask one last question. I know there are differing thoughts on ``too big to fail,'' but each of you feel that that is a big issue, how to deal with that. I know that I would like to see a resolution mechanism in place where they resolve much like Chairman Bair proposes. Mr. Dugan, I don't understand how, if you continue to give Treasury the ability to solve the problem with taxpayer money if they deem it an important thing to do, I don't understand how that creates any market discipline. It seems to me that leaving that vague line in place defeats all market discipline. I don't understand how you can cause those to measure up or how we could craft something that actually worked and caused people like the Senator from Ohio's constituents and mine, which I think are different in thinking about some things, but I think they would agree that that is wrong, and yet you propose keeping it in place and I don't understand that. " FOMC20061212meeting--221 219,VICE CHAIRMAN GEITHNER.," Let me just say a couple of things. I think Rick’s point about education is right. You can make a statement educating people about the virtues of price stability and anchoring long-term inflation expectations and the reason that’s important, without taking on the challenge of educating people today about alternative ways of achieving that objective. Our debate about inflation targeting and communications is really about means not ends; and my view about education on the latter issue about means is to avoid taking on the challenge of educating the public until we know where we want to go. Once we know where we want to go, we can figure out how best to create the broader public foundation to make that possible. I’m sure that we’ll have different views on that. My second point is about past positions. This is easy for me because I don’t have past positions about these issues to echo or to repudiate in public. I would make a slightly different suggestion for the way to respond to those questions from, I think, Bill. You can refer people to your past positions without repeating them in substance and nuance. I don’t know what the Chairman and the Vice Chairman of the Board plan to do, but I expect that you won’t feel the need in public going forward to repeat your past positions on these issues. I suspect that you will refer people to your past positions without reminding them about what those were. That distinction is important, I think, because I don’t know how you get into repeating or summarizing your past position without inevitably getting into the broader set of choices that we’re going to be debating in the Committee. One final point, and I think Don said this more eloquently than I can say it, which is that we all have an interest in having this discussion take place below the radar screen of public debate until, again, we have a better sense of where consensus is going to lie. The more we move it into the public debate, the more risk we face of all the concerns that Governor Kohn referred to." CHRG-111shrg51290--44 Mr. Bartlett," You know, it never strikes me as appropriate to go out and lock the barn door after the horses are out, but it wouldn't do any harm in the near term. The difficulty is any time that you create some kind of a Federal ban for something that somebody used to do, well, then 5 years from now, you will discover that it is getting in the way of something that consumers want. It wouldn't do any harm. It just doesn't strike me as being all that useful at this point. Senator Merkley. Ellen Seidman? Ms. Seidman. I think that the combination of teaser rates and a prepayment penalty is a combination that has no redeeming social value. I would ban it. And I am pleased to hear that Steve says that, in general, prepayment penalties are disappearing. I think they are pernicious and if they are to exist, they should be limited to a very short period of time, certainly as the Fed has done, no longer than the initial adjustment. They should come off before the initial adjustment in the mortgage rate. Senator Merkley. Thank you, and Professor? Ms. McCoy. I have nothing more to add with Ms. Seidman. I totally agree with her. Senator Merkley. There are those who have argued that, really, if you get rid of the prepayment penalty, teaser rates take care of themselves because obviously you are only going to get a slight discount. A finance lender is not going to offer you a big discount if you could go ahead and refinance 2 years later into another low discount. Do you all share that opinion, that really the focus is on the prepayment penalty? If you take care of that, the teaser rate issue takes care of itself? Ms. Seidman. That is probably right in logic. However, I think the problem on the teaser rates is that when you are dealing with a population that doesn't have a fiduciary looking out for them and is not really familiar with how mortgages work, it is too easy to sell the low monthly payment. " CHRG-111hhrg67816--151 Mr. Leibowitz," Yes. We brought a case, I think in 2002-2003 before I got to the Commission freecreditreport.com. I think I am summarizing it but I believe they are actually charging fees. There is a place where consumers can go to get a free credit report without entering into a contract, a monthly contract, and I think that is called annual credit report. And we actually, not to make light of this, but we actually put out a spoof of freecreditreport.com that got picked up by You Tube and by a variety of other media outlets just 2 weeks ago. So this is an area of some concern to us, and I know the consumers--we do get complaints on this. " CHRG-111shrg52619--182 RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM JOHN C. DUGANQ.1. It is clear that our current regulatory structure is in need of reform. At my subcommittee hearing on risk management, March 18, 2009, GAO pointed out that regulators often did not move swiftly enough to address problems they had identified in the risk management systems of large, complex financial institutions. My questions may be difficult, but please answer the following: If this lack of action is a persistent problem among the regulators, to what extent will changing the structure of our regulatory system really get at the issue? Along with changing the regulatory structure, how can Congress best ensure that regulators have clear responsibilities and authorities, and that they are accountable for exercising them ``effectively and aggressively''?A.1. As was discussed in Senior Deputy Comptroller Long's March 18th testimony before the Subcommittee on Securities, Insurance, and Investment, looking back on the events of the past two years, there are clearly things we may have done differently or sooner, but I do not believe our supervisory record indicates that there was a ``lack of action'' by the OCC. For example, we began alerting national banks to our concerns about increasingly liberal underwriting practices in certain loan products as early as 2003. Over the next few years, we progressively increased our scrutiny and responses, especially with regard to credit cards, residential mortgages, and commercial real estate loans even though the underlying ``fundamentals'' for these products and market segments were still robust. Throughout this period, our examiners were diligent in identifying risks and directing banks to take corrective action. Nonetheless, we and the industry initially underestimated the magnitude and severity of the disruptions that we have subsequently seen in the market and the rapidity at which these disruptions spilled over into the overall economy. In this regard, we concur with the GAO that regulators and large, complex banking institutions need to develop better stress test mechanisms that evaluate risks across the entire firm and that identify interconnected risks and potential tail events. We also agree that more transparency and capital is needed for certain off-balance sheet conduits and products that can amplify a bank's risk exposure. While changes to our regulatory system are warranted--especially in the area of systemic risk--I do not believe that fundamental changes are required to the structure for conducting banking supervision.Q.2. How do we overcome the problem that in the boom times no one wants to be the one stepping in to tell firms they have to limit their concentrations of risk or not trade certain risky products? What thought has been put into overcoming this problem for regulators overseeing the firms? Is this an issue that can be addressed through regulatory restructure efforts?A.2. A key issue for bankers and supervisors is determining when the accumulation of risks either within an individual firm or across the system has become too high, such that corrective or mitigating actions are needed. Knowing when and how to strike this balance is one of the most difficult jobs that supervisors face. Taking action too quickly can constrain economic growth and impede access to credit by credit-worthy borrowers. Waiting too long can result in an overhang of risk becoming embedded into banks that can lead to failure and, in the marketplace, that can lead to the types of dislocations we have seen over the past year. This need to balance supervisory actions, I believe, is fundamental to bank supervision and is not an issue that can be addressed through regulatory restructure--the same issue will face whatever entity or agency is ultimately charged with supervision. There are, however, actions that I believe we can and should take to help dampen some of the effects of business and economic cycles. First, as previously noted, I believe we need to insist that large institutions establish more rigorous and comprehensive stress tests that can identify risks that may be accumulating across various business and product lines. As we have seen, some senior bank managers thought they had avoided exposure to subprime residential mortgages by deliberately choosing not to originate such loans in the bank, only to find out after the fact that their investment banks affiliates had purchased subprime loans elsewhere. For smaller, community banks, we need to develop better screening mechanisms that we can use to help identify banks that are building up concentrations in a particular product line and where mitigating actions may be necessary. We have been doing just that for our smaller banks that may have significant commercial real estate exposures. We also need to ensure that banks have the ability to strengthen their loan loss reserves at an appropriate time in the credit cycle, as their potential future loans losses are increasing. A more forward-looking ``life of the loan'' or ``expected loss'' concept would allow provisions to incorporate losses expected over a more realistic time horizon, and would not be limited to losses incurred as of the balance sheet date, as under the current regime. Such a revision would help to dampen the decidedly pro-cyclical effect that the current rules are having today. This is an issue that I am actively engaged in through my role as Chairman of the Financial Stability Board's Working Group on Provisioning. Similarly, the Basel Committee on Bank Supervision recently announced an initiative to introduce standards that would promote the build up of capital buffers that can be drawn upon in periods of stress. Such a measure could also potentially serve as a buffer or governor to the build up of risk concentrations. There are additional measures we could consider, such as establishing absolute limits on the concentration a bank could have to a particular industry or market segment, similar to the loan limits we currently have for loans to an individual borrower. The benefits of such actions would need to be carefully weighed against the potential costs this may impose. For example, such a regime could result in a de facto regulatory allocation of credit away from various industries or markets. Such limits could also have a disproportionate affect on smaller, community banks whose portfolios by their very nature, tend to be concentrated in their local communities and, often, particular market segments such as commercial real estate.Q.3. As Mr. Tarullo and Mrs. Bair noted in their testimony, some financial institution failures emanated from institutions that were under federal regulation. While I agree that we need additional oversight over and information on unregulated financial institutions, I think we need to understand why so many regulated firms failed. Why is it the case that so many regulated entities failed, and many still remain struggling, if our regulators in fact stand as a safety net to rein in dangerous amounts of risk-taking?A.3. As alluded to in Governor Tarullo and Chairman Bair's testimonies, most of the prominent failures that have occurred and contributed to the current market disruption primarily involved systemically important firms that were not affiliated with an insured bank and were thus not overseen by the Federal Reserve or subject to the provisions of the Bank Holding Company Act. Although portions of these firms may have been subject to some form of oversight, they generally were not subject to the type or scope of consolidated supervision applied to banks and bank holding companies. Nonetheless, large national banking companies clearly have not been immune to the problems we have seen over the past eighteen months and several have needed active supervisory intervention or the assistance of the capital and funding programs instituted by the U.S. Treasury, Federal Reserve, and FDIC. As I noted in my previous answer, prior to the recent market disruptions our examiners had been identifying risks and risk management practices that needed corrective action and were working with bank management teams to ensure that such actions were being implemented. We were also directing our large banks to shore up their capital levels and during the eight month period from October 2007 through early June 2008, the largest national banking companies increased their capital and debt levels through public and private offerings by over $100 billion. I firmly believe that our actions that resulted in banks strengthening their underwriting standards, increasing their capital and reserves, and shoring up their liquidity were instrumental to the resilience that the national banking system as whole has shown during this period of unprecedented disruption in bank funding markets and significant credit losses. Indeed several of the largest national banks have served as a source of strength to the financial system by acquiring significant problem thrift institutions (i.e., Countrywide and Washington Mutual) and broker-dealer operations (i.e., Bear Stearns and Merrill Lynch). In addition, we worked to successfully resolve via acquisition by other national banks, two large national banks--National City and Wachovia--that faced severe funding pressures in the latter part of 2008. While both of these banks had adequate capital levels, they were unable to roll over their short term liabilities in the marketplace at a time when market perception and sentiment for many banking companies were under siege. Due to these funding pressures, both banks had to be taken over by companies with stronger capital and funding bases. As the breadth and depth of credit problems accelerated in late 2008, two other large banking companies, Citigroup and Bank of America, required additional financial assistance through Treasury's Asset Guarantee and Targeted Investment programs to help stabilize their financial condition. As part of the broader Supervisory Capital Assessment Program that the OCC, Federal Reserve, and FDIC recently conducted on the largest recipients of funds under the Treasury's Troubled Assets Relief Program, we are closely monitoring the adequacy of these firms' capital levels to withstand further adverse economic conditions and will be requiring them to submit capital plans to ensure that they have sufficient capital to weather such conditions. In almost all cases, our large national banking organizations are on track to meet any identified capital needs and have been able to raise private capital through the marketplace, a sign that investor confidence may be returning to these institutions. While the vast majority of national banks remain sound, many national banks will continue to face substantial credit losses as credit problems work through the banking system. In addition, until the capital and securitization markets are more fully restored, larger banks will continue to face potential liquidity pressures and funding constraints. As I have stated in previous testimonies, we do expect that the number of problem banks and bank failures will continue to increase for some time given current economic conditions. In problem bank situations, our efforts focus on developing a specific plan that takes into consideration the ability and willingness of management and the board to correct deficiencies in a timely manner and return the bank to a safe and sound condition. In most instances our efforts, coupled with the commitment of bank management, result in a successful rehabilitation of the bank. There will be cases, however, where the situation is of such significance that we will require the sale, merger, or liquidation of the bank, if possible. Where that is not possible, we will appoint the FDIC as receiver.Q.4. While we know that certain hedge funds, for example, have failed, have any of them contributed to systemic risk?A.4. The failure of certain hedge funds, while not by themselves systemically important (in contrast to the failure of Long Term Capital Management in 1998), led to a reduction in market liquidity as leveraged investors accelerated efforts to reduce exposures by selling assets. Given significant uncertainty over asset values, reflecting sharply reduced market liquidity, this unwinding of leveraged positions has put additional strains on the financial system and contributed to lack of investor confidence in the markets.Q.5. Given that some of the federal banking regulators have examiners on-site at banks, how did they not identify some of these problems we are facing today?A.5. At the outset, it is important to be clear that bank examiners do not have authority over the nonbank companies in a holding company. These nonbank firms were the source of many of the issues confronting large banking firms. With respect to banks, as noted above, we were identifying issues and taking actions to address problems that we were seeing in loan underwriting standards and other areas. At individual banks, we were directing banks to strengthen risk management and corporate governance practices and, at some institutions, were effecting changes in key managerial positions. Nonetheless, in retrospect, it is clear that we should have been more aggressive in addressing some of the practices and risks that were building up across the banking system during this period. For example, it is clear that we and many bank managers put too much reliance on the various credit enhancements used to support certain collateralized debt obligations and not enough emphasis on the quality of, and correlations across, the underlying assets supporting those obligations. Similarly, we were not sufficiently attuned to the systemic risk implications of the significant migration by large banks to an ``originate-to-distribute model'' for commercial and leveraged loan products. Under this model, banks originated a significant volume of loans with the express purpose of packaging and selling them to institutional investors who generally were willing to accept more liberal underwriting standards than the banks themselves would accept, in return for marginally higher yields. In the fall of 2007, when the risk appetite of investors changed dramatically (and at times for reasons not directly related to the exposures they held), banks were left with significant pipelines of loans that they needed to fund, thus exacerbating their funding and capital pressures. As has been well-documented, similar pressures were leading to relaxation of underwriting standards within the residential mortgage loan markets. While the preponderance of the subprime and ``Alt-A'' loans that have been most problematic were originated outside of the national banking system, the subsequent downward spiral in housing prices that these practices triggered have clearly affected all financial institutions, including national banks. ------ CHRG-111shrg57319--188 Mr. Cathcart," When you say what was going on, I am---- Senator Coburn. Well, I am talking about the fraud, from Westlake to all these others, the idea that the incentive was paying people to get loans done whether they were qualified or not. Nobody knows exactly what percentage of the portfolio of loans they were making were in that category, but it was a significant number, everybody would agree. Would you consider that a material adverse condition for Washington Mutual? " CHRG-110hhrg46595--543 Mr. Friedman," I would argue to accelerate that money under the same conditions, and I would argue--I think the panel has discussed that there are two other sources for that money. We have to make sure that these companies, as Professor Sachs said, are planning for an macroeconomic recovery. And in a macroeconomic recovery, gas prices are going to shoot up as China and India and the other countries start guzzling gas more. And these companies are going to be in trouble again if a-- " FOMC20070321meeting--181 179,MS. MINEHAN.," You could do something like “still, taken all together, the economy seems likely to expand at a moderate pace.” I think that Governor Kroszner was right on. In terms of the shortness of this language, highlighting these three things really does run the risk that they will appear to be things on which we are going to focus a lot of attention. We don’t want to convey, particularly in the message on financial conditions, that that’s where we’re going to put our attention." FOMC20080310confcall--76 74,CHAIRMAN BERNANKE.," Thank you. On exit strategies, we do get a lot of feedback from the auction itself, of course, in terms of demand and price, and we can monitor the market conditions. Obviously, we'll keep you well apprised of developments in the markets and in the auction. I'm a little worried about having a firm cutoff date ex ante. If we want the dealers to make markets, we need them to feel that there will not be an arbitrary cutoff when the situation is still in a turbulent state. But that's just a thought. President Evans. " FOMC20060629meeting--199 197,MS. DANKER.," I’ll be reading the directive wording from page 29 of the Bluebook and the assessment of risk from the table that was handed out with Vincent’s briefing. “The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 5¼ percent.” And “Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.” Chairman Bernanke Yes Vice Chairman Geithner Yes Governor Bies Yes President Guynn Yes Governor Kohn Yes Governor Kroszner Yes President Lacker Yes President Pianalto Yes Governor Warsh Yes President Yellen Yes" FinancialCrisisReport--33 Conflicts of Interest. Credit rating agencies are paid by the issuers seeking ratings for the products they sell. Issuers and the investment banks want high ratings, whether to help market their products or ensure they comply with federal regulations. Because credit rating agencies issue ratings to issuers and investment banks who bring them business, they are subject to an inherent conflict of interest that can create pressure on the credit rating agencies to issue favorable ratings to attract business. The issuers and investment banks engage in “ratings shopping,” choosing the credit rating agency that offers the highest ratings. Ratings shopping weakens rating standards as the rating agencies who provide the most favorable ratings win more business. In September 2007, Moody’s CEO described the problem this way: “What happened in ’04 and ’05 with respect to subordinated tranches is that our competition, Fitch and S&P, went nuts. Everything was investment grade.” 50 In 2003, the SEC reported that “the potential conflicts of interest faced by credit rating agencies have increased in recent years, particularly given the expansion of large credit rating agencies into ancillary advisory and other businesses, and the continued rise in importance of rating agencies in the U.S. securities markets.” 51 Mass Downgrades. The credit ratings assigned to RMBS and CDO securities are designed to last the lifetime of the securities. Because circumstances can change, however, credit rating agencies conduct ongoing surveillance of each rated financial product to evaluate the rating and determine whether it should be upgraded or downgraded. Prior to the financial crisis, the numbers of downgrades and upgrades for structured finance ratings were substantially lower. 52 Beginning in July 2007, however, Moody’s and S&P issued hundreds and then thousands of downgrades of RMBS and CDO ratings, the first mass downgrades in U.S. history. From 2004 through the first half of 2007, Moody’s and S&P provided AAA ratings to a majority of the RMBS and CDO securities issued in the United States, sometimes providing AAA ratings to as much as 95% of a securitization. 53 By 2010, analysts had determined that over 90% of the AAA ratings issued to RMBS securities originated in 2006 and 2007 had been downgraded to junk status. 54 48 3/14/2008 compliance letter from S&P to SEC, SEC_OCIE_CRA_011218-59, at 18-19. (See Chapter V below.) 49 “Revenue of the Three Credit Rating Agencies: 2002-2007,” chart prepared by the Subcommittee using data from http://thismatter.com/money, Hearing Exhibit 4/23-1g. 50 9/10/2007 Transcript of Raymond McDaniel at Moody’s MD Town Hall Meeting, Hearing Exhibit 4/23-98. 51 1/2003 “Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets,” prepared by the SEC, at 40. The report continued: “[C]oncerns had been expressed that a rating agency might be tempted to give a more favorable rating to a large issue because of the large fee, and to encourage the issuer to submit future large issues to the rating agency.” Id. at 40 n.109. 52 See, e.g., 3/26/2010 “Fitch Ratings Global Structured Finance 2009 Transition and Default Study,” prepared by Fitch. 53 See “MBS Ratings and the Mortgage Credit Boom,” Federal Reserve Bank of New York Staff Report no. 449, May 2010, at 1. 54 See, e.g., “Percent of the Original AAA Universe Currently Rated Below Investment Grade,” chart prepared by BlackRock Solutions, Hearing Exhibit 4/23-1i. See also 3/2008 “Understanding the Securitization of Subprime Mortgage Credit,” Federal Reserve Bank of New York Staff Report no. 318, at 58 and chart 31 (“92 percent of 1st- fcic_final_report_full--4 CONCLUSIONS OF THE FINANCIAL CRISIS INQUIRY COMMISSION The Financial Crisis Inquiry Commission has been called upon to examine the finan- cial and economic crisis that has gripped our country and explain its causes to the American people. We are keenly aware of the significance of our charge, given the economic damage that America has suffered in the wake of the greatest financial cri- sis since the Great Depression. Our task was first to determine what happened and how it happened so that we could understand why it happened. Here we present our conclusions. We encourage the American people to join us in making their own assessments based on the evi- dence gathered in our inquiry. If we do not learn from history, we are unlikely to fully recover from it. Some on Wall Street and in Washington with a stake in the status quo may be tempted to wipe from memory the events of this crisis, or to suggest that no one could have foreseen or prevented them. This report endeavors to expose the facts, identify responsibility, unravel myths, and help us understand how the crisis could have been avoided. It is an attempt to record history, not to rewrite it, nor allow it to be rewritten. To help our fellow citizens better understand this crisis and its causes, we also pres- ent specific conclusions at the end of chapters in Parts III, IV, and V of this report. The subject of this report is of no small consequence to this nation. The profound events of  and  were neither bumps in the road nor an accentuated dip in the financial and business cycles we have come to expect in a free market economic system. This was a fundamental disruption—a financial upheaval, if you will—that wreaked havoc in communities and neighborhoods across this country. As this report goes to print, there are more than  million Americans who are out of work, cannot find full-time work, or have given up looking for work. About four million families have lost their homes to foreclosure and another four and a half million have slipped into the foreclosure process or are seriously behind on their mortgage payments. Nearly  trillion in household wealth has vanished, with re- tirement accounts and life savings swept away. Businesses, large and small, have felt the sting of a deep recession. There is much anger about what has transpired, and jus- tifiably so. Many people who abided by all the rules now find themselves out of work and uncertain about their future prospects. The collateral damage of this crisis has been real people and real communities. The impacts of this crisis are likely to be felt for a generation. And the nation faces no easy path to renewed economic strength. Like so many Americans, we began our exploration with our own views and some preliminary knowledge about how the world’s strongest financial system came to the brink of collapse. Even at the time of our appointment to this independent panel, much had already been written and said about the crisis. Yet all of us have been deeply affected by what we have learned in the course of our inquiry. We have been at various times fascinated, surprised, and even shocked by what we saw, heard, and read. Ours has been a journey of revelation. CHRG-110hhrg44901--62 Mr. Baca," Thank you very much, Mr. Chairman. Mr. Chairman, a combination of declining wealth, a weak job market probably because of all of the outsourcing and its impact that it has had on working families, rising gas, food prices, and foreclosures have created a downward turn on the economy. To put it into perspective: 94,000 jobs have been lost each month this year; 8,500 families are in foreclosure each day; 2.5 million foreclosures are expected in the year 2008; home prices have fallen, stripping away household wealth and equity; the value of the dollar has dropped between 20 to 30 percent; inflation is raising quickly; unemployment has risen to 5.5 percent; and the real wages have fallen to the level of 2001 value. More importantly is the real impact these numbers have on families. I go back home and my constituents are asking me, what are you doing to bring down the gas prices and what are you doing to help stop the foreclosures? Families are struggling to make ends meet. They are forced to pick and choose between basic necessities that they can afford each month, food, house payments, child care or gas. You stated that the growth in the second half of this year would be well below the trend due to continued weakening in the house markets, elevated energy prices, and tight credit conditions. But you stopped short at predicting a recession. Question number one: Is the worst yet to come? And how would you explain to the average American and to the working families who are feeling the impact every day that we are not in a recession? " FOMC20080724confcall--151 149,MR. ALVAREZ.," Sure. This is the first resolution on the third page. ""In addition to the current authorizations granted to the Federal Reserve Bank of New York to engage in term securities lending transactions, the Federal Open Market Committee authorizes the Federal Reserve Bank of New York to offer options on up to $50 billion in additional draws on the facility, subject to the other terms and conditions previously established for the facility."" " FOMC20080130meeting--76 74,MR. MADIGAN.," 3 I will be referring to the separate package labeled ""Material for FOMC Briefing on Economic Projections."" Table 1 shows the central tendencies and ranges of your current forecasts for 2008, 2009, and 2010. Central tendencies and ranges of the projections made by the Committee last October are shown in italics. As for conditioning assumptions, most of you see the appropriate near-term path of the federal funds rate as at or below that assumed in the Greenbook. Eight policymakers explicitly assumed somewhat more near-term easing than in the Greenbook. However, several of you assumed that policy would need to begin firming no later than 2009. Many of you also projected that the funds rate would exceed the level forecasted in the Greenbook by the end of the forecast period. As shown in the first row, first column, of table 1, the central tendency of your forecasts of real growth for 2008 has been marked down about � percentage point since last October. Most of you remarked that a range of factors had prompted you to lower your growth expectations for the current year, including the continued turmoil in financial markets and the resulting tightening of credit conditions, the persistent deterioration in the housing market, incoming data suggesting slower consumption expenditures and business investment growth, and higher oil prices. A few of you suggested that stronger export demand as well as fiscal stimulus would provide some offset to weakness in private domestic demand, particularly beginning later this year. Your half-yearly projections, not shown, suggest that you all think that, more likely than not, the economy will skirt recession. On average, you see real GDP growing at an annual rate of about � percentage point over the first half before picking up to a 2� percent pace in the second half. As shown in the second row, in view of the weak growth forecast for this year, most of you revised up your expectations for the unemployment rate in the fourth quarter about 0.4 percentage point, to around 5� percent. Most of you project slightly brisker growth this year than the Greenbook does--perhaps partly reflecting the assumption that a number of you made that there would be more near-term monetary ease than the staff assumed. As shown in the third and fourth sets of rows, with incoming inflation data a bit higher than previously expected and despite projected weaker real activity, the central tendencies of your projections for total and core PCE inflation this year have increased about 0.3 percentage point. That upward revision is a bit larger than the 0.2 percentage point upward revision to the Greenbook inflation forecasts but leaves the level of your projections close to those in the Greenbook: Most of you see total and core 3 The materials used by Mr. Madigan are appended to this transcript (appendix 3). inflation this year at a little above 2 percent. But as shown in the bottom section, the upper limit of the range of your overall inflation projections for this year has moved up to 2.8 percent. Your forecasts for total PCE inflation this year remain a bit higher than for core inflation, reflecting the expectation of higher energy, food, and in some cases, import price inflation. Looking ahead to next year, your forecasts indicate that you expect economic growth to pick up as the drag from the housing sector dissipates and credit conditions improve. The midpoint of the central tendency of your forecasts for real GDP growth is 2.4 percent. Your growth forecasts for next year are mostly above the staff's forecast of 2.2 percent, perhaps again because a number of you assumed moreaggressive policy easing in the near term and perhaps because at least some of you appear to see potential output growth as a bit brisker than the staff does. With most of you evidently seeing growth a bit above trend next year, the unemployment rate begins to edge lower, but the central tendency of your unemployment projections still remains distinctly above that in October. Although you are generally optimistic about improving conditions next year, your views have become considerably more dispersed: As shown in the lower section, the width of the range of the growth projections for 2009 has nearly doubled, as has the width of the range of the unemployment projections. The third and fourth sets of rows in the upper panel indicate that most of you see overall and core inflation as moving below 2 percent next year. Some of you said that those declines reflect less pressure from energy prices and, with the unemployment rate above the NAIRU, the emergence of some slack in the labor market. It is worth noting, however, that despite the easing of pressure on resources during 2008 and 2009, the central tendencies of your inflation projections for next year are essentially unchanged from October. This development presumably reflects your perception of some deterioration in the near-term inflationoutput tradeoff, perhaps prompted in part by the publication of surprisingly high inflation data for the fourth quarter of 2007 and an expectation that those effects will linger in 2009. Turning to 2010, the interpretation of your longer-term projections is a bit less straightforward than it was in October. It was noted during the trial-run phase that a time may come when the economy is seen as unlikely to be in a steady state by the third year of the projection. To some extent, that time seems to have already arrived. In particular, a comparison of the central tendencies for unemployment in 2010 from your January and October projections suggests that you now see a bit of slack persisting that year. The central tendencies and ranges of your total and core inflation projections for 2010 have changed just a bit from those in October, but those changes might be viewed by outside analysts as significant. In particular, the central tendency for total inflation in 2010 has inched up 0.1 percentage point, and the lower limit of the central tendency for core inflation has increased the same amount. Absent guidance to the contrary, some analysts might now conclude that your ""comfort zone"" has edged up to 1� to 2 percent from 1� to 2 percent. To counter this impression, presumably the published ""Summary of Economic Projections"" should suggest that, because a bit of economic slack is expected to persist at the end of 2010, inflation could continue to edge lower beyond the projection period. This discussion, however, raises not only a presentational point but also a substantive one, and that is, Why should your inflation projections for 2010 have revised up at all? True, the inflation-output tradeoff appears to have deteriorated a little recently, but as Dave Reifschneider noted, some of that deterioration is likely to be temporary. Also, higher inflation than otherwise might in principle be a consequence of taking out some insurance now against especially weak economic outcomes. But given the significant negative shock to aggregate demand embedded in your modal forecasts and the associated upward revision to slack across all three years of your projections, as well as the absence of any upward revision to your inflation projections for 2009, even the small upward revision to your inflation projections in 2010 seems somewhat surprising. Turning to the uncertainties in the outlook, the upper panel of exhibit 2 shows that even more of you than in October judge that uncertainty regarding prospects for economic activity is higher than its historical level. Even with the significant reductions in the target funds rate already in place and, for many of you, an assumption of more easing to come, the lower panel illustrates that most of you still see the risks to growth as tilted to the downside. As reasons, you again cited tighter credit conditions for households and businesses emanating from further disruptions in financial markets as well as the persistently deteriorating housing outlook. As shown in the upper panel of exhibit 3, more of you than in October see the uncertainty around your total inflation forecasts as close to that of the past two decades, while a smaller minority viewed uncertainty as greater than in the past. As shown in the lower panel, fewer of you now see the inflation risks as predominantly to the upside. On balance, as in October, downside risks to growth were more frequently cited than upside risks to inflation, which seems broadly consistent with each of the alternative policy statements that were in Bluebook table 1. Thank you. " FOMC20080430meeting--206 204,VICE CHAIRMAN GEITHNER.," Okay, but it is a surprising gap. So I think it would be worth some time to think through that. Obviously we also disagree about how inflation works in the United States, how relative price shocks take effect, and what we should respond to in that sense. That would be worth a little time, too. Again, it is a surprise to me. We sit here to make monetary policy, and we haven't talked much about this basic core question: How should we judge the stance of policy? It would be worth some attention. I just want to end by saying something about the dollar. My basic sense about the dollar-- and I'm very worried about this dynamic now--is that it has been trading more on concern about tail risk in the economy and in the financial system than anything else. As I said yesterday, if you look back to when there has been an increase in perceived tail risk, however you want to measure it--credit default swaps on financials or something like that--and the two-year has fallen sharply or we have had a big flight to quality, those have been the periods that have been most adverse to the dollar. Now, it is not a consistent pattern, but I think it's basically right; and I think it gives an important illustration that what goes into a judgment about whether people hold dollars and U.S. financial assets has to do with a lot of things. It has a lot to do with confidence that this Committee will reduce the tail risk in the financial system and the economy to tolerable levels. It also has a lot to do with confidence in our willingness to keep inflation stable over a long period, but it's not only that. Again, we have had a pretty good experiment in that proposition over the past year or so. My sense is that the biggest risk to the dollar, since I'm pretty confident that this Committee is going to make good judgments about inflation going forward, is in the monetary policy of other countries. The real problem for us now is that we have a large part of the world economy--in nonChina, non-Japan Asia and the major energy exporters--still running a monetary policy that is based on the dollar as nominal anchor. That has left them with remarkably easy monetary policy and a pretty significant rise in asset-price inflation. The transition ahead for them as they try to get more independence for monetary policy and soften the link to the dollar is going to carry a lot of risk for us because the market is going to infer from that a big shift in preferences for the currencies that both governments and private actors in those countries hold. As that evolution takes place in their exchange rate and monetary policy regimes the risk for us is that the market expects a destabilizing shift in portfolio preferences, which people might infer is also a loss of confidence in U.S. financial assets. I think that's a big problem for us. It's not clear to me that it means that we should run a tighter monetary policy against that risk than would otherwise be appropriate because I don't think it buys much protection against that risk. I just want to associate myself with all the concerns said about the dollar in this context. The judgment that goes into confidence and people's willingness to hold U.S. financial assets is deeply textured and complex, and it has a lot to do with confidence in this Committee's capacity to navigate the perilous path between getting and keeping down that tail risk and preserving the confidence that inflation expectations over time will stay stable. So I support alternative B and its language. " FOMC20080318meeting--90 88,MR. KROSZNER.," Thanks. I've talked many times before about the slow burn from the financial markets that is spreading out elsewhere. Unfortunately, I think the fire is a bit hotter than I had expected in my earlier discussions, and it comes particularly through capital pressures in the financial institutions. What we're seeing now is the simultaneity of stress in the housing market and stress in the financial markets, and they will be cured together. I think they are joined at the hip. Whether we have tools to address those directly is something we continue to discuss, but I think it is this direct connection that potentially leads to the negative feedback loop that we have discussed quite a bit. For housing, of course, there are the direct negative wealth effects but also the lingering uncertainty of what's going to happen, as many people have mentioned. Part of this comes from just a change in behavior. People are acting very differently during this housing cycle from in the past, so it is very difficult to predict the evolution of foreclosures even given a particular macroeconomic outcome. There's still the uncertainty of the macroeconomic outcome, but people are going delinquent much earlier--they are going delinquent on their houses before they go delinquent on their credit cards--and so it is really a different model of consumer behavior, which makes valuing the securities particularly problematic. This is, of course, in addition to uncharted territory in terms of real and nominal price declines. We'll see exactly how people will respond to these things. Obviously the markets are closed, and the banks have to keep these on their books, with higher cost and more difficulty financing. Some of the changes that came in with the stimulus package to raise the conforming limits for Freddie Mac and Fannie Mae have done little to bring down the spreads because they have significantly increased the cost of the guarantees given this new environment. It's not unreasonable to do that, but the potential benefit from the changes is lower than we might otherwise have hoped for. This is all having consequences for credit cards. Even though at first it was the mortgages, now we're starting to see a significant uptick in delinquencies on credit cards and spending, and a number of people--President Rosengren, President Yellen, and First Vice President Sapenaro-- have mentioned some of these things. I just want to report a bit from my conversations with some of the major credit card companies, which have kind of a window into real-time consumer spending. They are seeing a continuing flattening but not a falloff of growth. There's no collapse but certainly a continued downtrend, as I've been reporting over the past few months--a continuing slowing of payments and a continuing increase in delinquencies. Their so-called roll rates of people moving from 30 days behind to 60 days behind to 90 days behind continue to go up. They are still going up, although not significantly. They are concerned about that, but it is not spiking up. They are mainly concerned about when the roll rate gets into 90 to 180 days. They're not getting their money back. Personal bankruptcies are going up. The cure rates are much lower, and the recovery rates are much lower. So there seems to be a group of people who are getting into extreme financial difficulty. All the series that I've quoted are general averages. The contacts said that in areas of particular housing stress basically all of the numbers are three times as high. It is significantly more stressful there, showing a very clear link between stress in the housing market and these other stresses. Have they been responding? Well, because of very strong pressures that may be coming directly from us and certainly from Capitol Hill, the credit card companies don't respond by changing interest rates. They respond by reducing the amount of credit available, and that's exactly what they've been doing. So they've been cutting credit lines of a lot of people. Also, as I think President Yellen or a number of people mentioned, they're also cutting back on the HELOCs because they have been concerned that people are taking money out when no equity is there, and so they really want to pull back on that. These overall tightening credit conditions are reflecting the continued stress on the balance sheets of banks and financial institutions more generally; as you see with the Bear Stearns example, it's not just the depository institutions but a broader set of institutions that are creating pressures both on the asset side and on the funding side. We have had a lot of the SIVs and a lot of the other assets coming on board. Unplanned asset expansions may continue, particularly if the economy does go down. What now seem to be very good credits in the leveraged lending market may no longer be good credits. So the anecdotal evidence that you've been mentioning around the table could turn into further unplanned asset expansions if these things start to go south. Consumer write-offs, obviously, are another thing that is putting on funding pressure. Also as I think President Evans mentioned, interestingly there have been few actual losses that have occurred on many of these securities in terms of the inability to make the payments, although the losses in the value in the markets have been quite spectacular in some cases. Some of this has to do with the broad evaluation uncertainty. Some of it has to do with liquidity. I think this is where we have the direct link between liquidity and macro stability because the uncertainties in part are coming from the macro uncertainty about how housing markets will evolve. Obviously I have said this before. There are other factors that come in, but that's a big one. So doing something to provide some insurance against that or to help provide comfort that these markets can come back is important because there's a very close link between liquidity issues that we have been seeing, the unwillingness to finance, and the capital issues that have been coming from an incompleteness of markets. The markets just aren't there for people to be trading in. They are valuing things off an index. The index can't be arbitraged against the underlying markets because the underlying markets aren't there. So the index is doing something else. It's the only somewhat liquid market that's providing some hedging. It's driving that down, and people don't want to buy the underlying security because they'll have to take the mark against this index rather than the true value. If they have to take the mark against something that they think is going to be pushed down artificially, they're not going to buy the security in the first place. These kinds of continuing stress make me feel a little less optimistic about the bounce-back in '09 that's in the Greenbook, although I don't think it's ruled out. Just turning quickly to inflation, we have a bit of a paradox in what has gone on recently as everyone has said--significantly slowing growth over the past four to five months but no evidence of slowing in the pressure on commodity, energy, and agriculture prices. That's despite some slowing elsewhere in the world and expectations of slower growth. The PPI numbers that came out today raised some concerns that some of the good parts of the CPI will not be flowing through to PCE. Also, over the last year or two, when we've had the unemployment rate below 5 percent or 4� percent, whatever your favorite number is, where there would be pressure on wages, we haven't seen much pressure on wages. So I'm not sure that, if the unemployment rate goes significantly above 5 percent, we'll see much on the other side that will take pressure off wages to bring things down. So I do remain concerned there. But I think there's a final risk that, if commodity, energy, and agriculture prices do significantly move down, it could have a major effect on some of the emerging markets and some of our other trading partners. So there's a bit of a paradox here that, if there are some potential benefits of the slowdown to reduce these prices, that could actually also reduce export demand, which--as a number of people pointed out--is very important in the forecast for keeping this a shallow recession. So I remain concerned on both the growth front and the inflation front, but I do think that macro stability is probably the primary thing that we need to be thinking about right now. Thank you, Mr. Chairman. " FOMC20050920meeting--90 88,MR. STERN.," Thank you, Mr. Chairman. Let me start with a few pertinent facts about the District economy, both pre- and post-Katrina. Overall, the District economy remains healthy. Employment is continuing to advance modestly; and in at least a few geographic areas, it seems likely that employment gains are being constrained by a lack of available labor. Construction activity, both residential and nonresidential, is strong and/or improving. And one of the large credit card issuers in our District has reported—and I think this is reflective of national conditions—that repayments on credit card debt are up and charge-offs are at a 10-year low. Higher fuel prices so far have not led to production cutbacks or plant closings in the District. Where possible, firms are switching to less expensive sources of energy, and surcharges are, of course, common. Higher energy prices do, though, seem to be particularly adverse for local governments and for farmers, who are also adversely affected by the infrastructure destruction and disruption in the Gulf area. As for the effects of Katrina on the national economy, at the qualitative level I think we actually have considerable experience in analyzing these kinds of shocks, and in my view the Greenbook at that level has it essentially right. It seems to me, as others have commented, that in the short term we will get a disruption to growth followed by a rebound and presumably ultimately a resumption of trend growth. And, as far as inflation is concerned, I think we will get an acceleration ultimately followed by a return to trend, assuming that policy adheres more or less to the path that it would have followed. At the quantitative level, though, it seems to me difficult to say anything precise with a lot of confidence. But I would venture that in these circumstances—because of the concentration September 20, 2005 65 of 117 relative to the energy and transportation infrastructure—the amplitude of the swings, both in terms of growth and inflation, and perhaps the duration of the adjustment, would be extended. There’s a temptation, I suppose, to exaggerate this. After all, a relatively small part of the economy is affected. But it seems to me that, in any event, uncertainty has increased. And if this overall description is roughly appropriate, then I find thinking about monetary policy more complicated than it was formerly. Moreover, I don’t think the situation is going to get clarified in the near term, because the incoming data, of course, will be difficult to read, given that they will be affected in one way or another by both the disruption and the recovery efforts as they proceed. In these circumstances, I feel most comfortable falling back on fundamentals—namely, the flexibility and strength of the underlying economy, which I don’t think are affected by this. So I come out with a view that it’s appropriate to continue on our path of removing policy accommodation, and I would favor a ¼ point increase in the fed funds rate. Having said that, I think we are getting to the point where we’ve removed a lot of accommodation. And one of these days we need to consider that and also think about how that ought to affect the language in the statement." CHRG-111shrg57319--198 Mr. Melby," I do. I remember receiving the report, and, again, this was written by the Corporate Credit Review group. My only reaction would be to the first bullet regarding your comment earlier about the control weaknesses existed for some time. In my view, this is the same issue that has been reported not only by Risk Mitigation but, again, in our reports as well. Senator Levin. Mr. Cathcart, do you have any comment on this? " FOMC20071031meeting--56 54,MR. LACKER.," Thank you, Mr. Chairman. Conditions in the Fifth District’s housing sector continue to deteriorate. Sales have weakened further across most areas, and starts have pulled back sharply. Inventories are rising in part, we hear, because some residential investors have run short on patience and are listing their properties. The housing correction has been particularly acute on the outer edges of the Washington, D.C., metro area, and contacts from the area anticipate that additional slowing in more-central markets is likely. In addition, reports of home-price reductions are becoming more common around my District. Until recently the weakness looked to be mostly contained in housing, but spillovers into other sectors are beginning to appear. For example, our survey of the Fifth District manufacturing sector—which, by the way, is larger than the Philadelphia and New York manufacturing sectors combined—[laughter]" CHRG-110shrg50369--86 Chairman Dodd," By the way, I should have made that point. All opening statements and any supporting documents people want to have will all be included in the record, and I appreciate you raising that. Senator Bunning. Chairman Bernanke, can you explain what information or event caused the Fed to change its view on the conditions of the economy and the financial markets and led to the January 21 intermeeting rate cuts? " FOMC20081216meeting--241 239,MR. MADIGAN.," 4 Thank you, Mr. Chairman. I will be referring to the package labeled ""Material for FOMC Briefing on Monetary Policy Alternatives."" This package includes the October policy statement, draft policy statements for this meeting, and associated draft directives to the Desk. Alternatives A and B have been revised somewhat relative to the versions that were distributed in the Bluebook, partly reflecting yesterday's discussion. In addition, as shown in bold in paragraph 1 of alternative A, it seemed appropriate in current circumstances to incorporate a sentence on financial conditions, as the Committee has done in its recent statements; the same sentence has also been included in alternative B. We have presented a total of four policy alternatives for your consideration. Given the unusual circumstances, 4 The materials used by Mr. Madigan are appended to this transcript (appendix 4). the statements associated with all four alternatives depart to some degree from the statements that have typically been issued by the Committee in recent years. Alternative A represents the sharpest departure. Rather than starting with the policy action, the statement would begin by describing the economic situation, noting that the economic outlook has weakened further. It goes on to say that inflation pressures have diminished quickly and that inflation could decline for a time below the rates that best foster economic growth and price stability. Reflecting what seemed to be a consensus yesterday, the sentence in brackets articulating a medium-term inflation objective has been dropped. We have also bracketed the clause indicating that inflation could drop for a time to very low levels, partly because some Committee members might not yet be convinced that such an outcome is a serious risk at this time and to avoid raising such concerns prematurely. The third paragraph would indicate that the Committee judges that it is not useful to set a specific target for the funds rate. It would explain that judgment by noting that, as a result of the large volume of reserves provided through liquidity programs, the federal funds rate has already declined to very low levels. It would also note that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time, avoiding the use of the ""near zero"" phrase. The clause ""weak economic conditions are likely to warrant"" implies some conditionality, but the conditions under which rates would be raised are not spelled out. The fourth paragraph would set out a general plan for implementing unconventional policy to support the functioning of financial markets and stimulate the economy. It reiterates that the Federal Reserve will be buying agency debt and mortgage-backed securities and indicates that those purchases could be ramped up if conditions warrant. It indicates further that the FOMC is evaluating the potential benefits of buying longer-term Treasuries. It also indicates that the Federal Reserve will be considering other ways of using its balance sheet to support credit markets and economic activity. We suggested dropping the word ""actively"" to avoid a suggestion that a new facility will be announced imminently. Over recent months, the discount rate has moved in lockstep with the target federal funds rate, at a level � percentage point above that rate, and very recently the rates on required and excess reserves have been set essentially by formula equal to the target federal funds rate. Because a target federal funds rate would not be established under this alternative, those formulas could not be used. We have suggested that, under this alternative, the Board act to lower the discount rate 75 basis points, to � percent, and that the interest rates on required and excess reserve balances be reduced to � percent. The positive interest rates on reserves would maintain some upward pressure, albeit perhaps modest, on the federal funds rate, consistent with a view that there are some costs in terms of financial market performance of driving the funds rate literally to zero. The discount rate of � percent would maintain a fairly small penalty for borrowing at the window. In certain substantive respects, alternative B, the next page, is similar to alternative A. Most important, federal funds would trade at about the same very low rates as in alternative A, partly because the discount and reserves interest rates, discussed in paragraph 5, would be set at the same levels as in alternative A. Also, the wording of the rationale section of the statement--paragraphs 2 and 3--is essentially identical to the corresponding paragraphs for alternative A. However, alternative B differs from alternative A by explicitly setting a target range for the federal funds rate of 0 to � percent, as shown in paragraph 1. We have restructured the introduction to the discussion of unconventional policy measures in paragraph 5 so that it is generally similar to the corresponding paragraph in alterative A. Also, the final sentence of alternative A, paragraph 4, has been substituted as the last sentence of alternative B, paragraph 5. Both alternatives A and B would put the Committee clearly in the realm of unconventional policymaking going forward. The various policy interest rates would be reduced to very low levels, several unconventional policy tools will already have been implemented, and the statements would indicate clearly that further unconventional tools could be deployed. The Committee might choose either of these alternatives if members had an outlook similar to that of the Greenbook or if they were especially concerned about the downside risks. Both alternatives would constitute somewhat more vigorous policy action than market participants anticipate for this meeting, and accordingly it is possible that financial markets would respond favorably. On the other hand, there is some risk that confidence could be undermined if the main message that comes through is that the Federal Reserve is out of ammunition. As was noted yesterday, such alternatives place a premium on Fed communications that convincingly indicate that the Federal Reserve can still provide monetary stimulus. Under alternative C, on the next page, the Committee would reduce the federal funds target rate 50 basis points today. The Committee might choose this option if it agreed that further monetary stimulus is warranted by the evolving economic outlook but was unsure that it would be necessary, or desirable, to reduce the target federal funds rate to around zero. The rationale for the action presented in paragraphs 2 and 3 would be fairly similar to those of alternatives A and B. Paragraph 4 notes the downside risks to the outlook and indicates that the Committee will use all available tools to promote its dual objectives, suggesting that the Committee will consider further reductions in the target federal funds rate and that further liquidity measures could be forthcoming. You could fine-tune the message regarding the federal funds rate by explicitly indicating that you are willing to or not willing to cut the funds rate further. Under this alternative, we have assumed that the discount rate would be lowered in line with the target federal funds rate to 75 basis points; the draft included in the Bluebook erroneously indicated that the rate would be lowered to 50 basis points. Because the FOMC would set a target rate under this alternative, we have assumed that the reserves interest rates would continue to be set via the existing formulas, so that those rates would move down to � percent absent further changes to the target funds rate. As Bill noted yesterday, although these interest rates on reserves would provide some upward pressure on the funds rate, that pressure is likely to be more than offset by the large supply of reserves, and paragraph 7 notes that federal funds are likely to trade below � percent. Although this approach provides a straightforward expectation for the funds rate, it has an unappealing aspect in that the Committee would be changing its target while simultaneously admitting that the target will not be hit, implicitly raising the question of the meaning of the target. Nonetheless, this statement is likely consistent overall with market expectations, and a pronounced market reaction one way or the other seems unlikely. Under alternative D, the Committee would keep the target federal funds rate at 1 percent. The rationale portion of the statement would acknowledge that the nearterm outlook has deteriorated and that significant downside risks are present. However, the statement would note that the broad range of policy actions taken in recent months should help, over time, to improve credit conditions and support a return to moderate growth. The statement would recognize that the federal funds rate would likely average significantly below the target for some time, but it would not imply that a further reduction of the target rate is being contemplated. It thus suggests that the Committee would seek to return the actual federal funds rate to 1 percent over time. Overall, this statement would surprise market participants considerably, both in terms of the decision regarding the target funds rate and in suggesting that further monetary policy stimulus, through conventional or unconventional policy, is unlikely. The final two pages of the package provide draft directives to the Desk that incorporate some changes relative to the versions that were included in the Bluebook. The directive for alternative A would provide some quantitative guidance for the Desk's open market operations while reserving some role for an assessment of evolving market conditions, specifically the language that ""the Committee directs the Desk to purchase GSE debt and agency-guaranteed MBS, with the aim of providing support to the mortgage and housing markets. The timing and pace of these purchases should depend on conditions in the markets for such securities and on a broader assessment of conditions in primary mortgage markets and the housing sector. By the end of the second quarter of next year, the Desk is expected to purchase up to $100 billion in housing-related GSE debt and up to $500 billion in agency-guaranteed MBS."" The directive would not specify a target range for the federal funds rate, while that for alternative B would. The directive for alternative A would state explicitly that the Committee has suspended setting a target for the federal funds rate and that it expects federal funds to trade at exceptionally low levels. The directive for B establishes the fed funds range of 0 to � percent. In line with one of the points raised yesterday, that the size and the composition of our entire balance sheet affect the Federal Reserve's monetary policy stance, the final sentence of the revised directives for alternatives A and B states an expectation that the SOMA Manager and the Committee's Secretary will keep the Committee informed of ongoing developments regarding the System's balance sheet that could affect the attainment over time of the Committee's objectives of maximum employment and price stability. The directive for alternative C, on the next page, is generally similar to that for alternative B. But it would acknowledge that federal funds are likely to trade below the � percent target rate set under this alternative. The directive for alternative D would include a similar recognition but with a target federal funds rate of 1 percent. In addition, this alternative would not provide specific guidance on open market purchases. Thank you, Mr. Chairman. " CHRG-110shrg50420--89 Mr. Kepplinger," Largely through the conditions, Senator, that were imposed upon the commitment and the extension of the loan guarantees, you were accomplishing that restructuring and those concessions had to be reflected in the financing plan. There was a dollar-for-dollar draw down in terms of the amount of loan guarantees that the board could provide to Chrysler had to be matched dollar for dollar with concessions from the stakeholder community. So you certainly can build that in. " CHRG-110hhrg46594--50 Mr. Kanjorski," Then, Mr. Wagoner, you would be agreeable that we find some methodology to buy some time here. So can you tell me when will General Motors run out of money relatively in the near future and what amount of money would you need now to be prevent that insolvency so that we can take the 3 months necessary to really go into depth of what conditions and how this agreement or bridge loan should be made? " CHRG-111shrg57319--86 Mr. Cathcart," I reported regularly to the Audit Committee and to the Finance Committee during each of their meetings, and every 6 months, I gave a full risk report to the full Board of Directors. My first report was in the middle of 2006. I think it was April 2006. During those meetings, I went through all of the risk functions which reported to Enterprise Risk Management, starting with credit risk, obviously. But it included credit risk, market risk, operational risk, compliance, internal audit, which reported to me administratively. But I summarized findings in that report. Liquidity risks, regulatory relations, which were the groups that reported to me. In those reports, I highlighted for the Board what I saw at the time and what our group saw at the time as the five top risks that the bank was confronting at the time of the report. Senator Coburn. And were the items that Senator Levin highlighted, Exhibits 10 and 22 in terms of this own internal look--are you aware that at any time the Board was made aware of each of those studies, whether the CEO or others were? Was the Board as a whole ever made aware of those studies, that you are aware of? " CHRG-111shrg51290--34 Chairman Dodd," Thank you, Senator, very much. Let me say, if I can, and some of these questions have been asked, that we have talked a lot about the brokers and the lack of regulation at that level of the chain. In fact, I remember at a hearing we had here, I think Senator Shelby and Senator Schumer will remember, we had displayed the Web site of the brokers at the time--this was back about 2 years ago--and on the Web site, the first rule was, convince the borrower you are their financial advisor. That was the first rule. And, of course, that was fairly easy to do in Committee ways. You are talking about people who are relatively unaccustomed to all of this. I was with a group of bankers not long ago and I asked them a question I suppose all of us ask ourselves any time we have been to a closing. How many times do we find ourselves with the lawyers there with the tabs and sign the tabs and we don't find ourselves reading everything. We assume that these things are pretty boilerplate, standardized stuff and accept it for what it is. And so the idea that there is this level playing field between the borrower and the lender, any more than there is between the patient and a physician in cases of medical malpractice, is questionable. Obviously, the borrower and the patient have responsibilities. That is not to suggest they don't have any, but the suggestion somehow that they are both equal in terms of that moment of bargaining is, I think, something that most of us--all of us--would recognize as being unrealistic. I am interested in, and this is a point that Professor McCoy made, why we have focused largely on the problem at origination. Professor McCoy, you lay out in your testimony the role played by Wall Street. Essentially, you argue that it was the demand for product to securitize that drove the lending standards down, not the other way around. And I wonder whether or not you, Ms. Seidman, would agree with that and how you feel about that, Steve. Ms. Seidman. I think both work. The collapse of the subprime market was the trigger here, but the fact that there was a gigantic bubble to break happened because of the investment side demand. Who knows what other products would have been created to fill that demand if the mortgage products hadn't. The mortgage products had a big advantage. They were regarded as extremely safe and producing rates of return that were significantly higher than Treasuries. And, of course, back in the 1990s, mortgage products were extremely safe and produced higher returns than Treasuries. So I think both were definitely part of the problem and that if we had just had lax consumer protection without the investment side, we would have had a problem for a lot of consumers, but we probably wouldn't have had a global international crisis. " FOMC20051101meeting--107 105,MR. LACKER.," Yes. On this point, what President Poole is suggesting is well posed. It’s a forecast conditioned on replicating sort of an arbitrage-free set of observable financial asset prices going forward. I don’t want it, though, because I want a mixture of the information that is conveyed by the market and the staff’s judgment. I want a combination of that. The approach you suggest is a useful exercise to ponder. But as long as the staff is clear about how their assumptions differ from those embodied in market prices, I’d rather see a combination, personally." FOMC20060808meeting--48 46,MR. MOSKOW.," Thank you, Mr. Chairman. Economic conditions in the Seventh District moderated in the second quarter in line with our expectations after a very strong first quarter. Most of my directors and business contacts believe that added caution is taking hold in the economy. Some think that growth will be noticeably slower in the second half of the year, and some believe that slowing will continue into 2007. However, my contacts are unable to point to explicit examples, apart from housing, showing that such a marked deceleration currently is in train. Indeed, many of the reports that we get are quite upbeat. For instance, one of our national temporary help contacts said his indicators were pointing to a bounceback from a weak second quarter, and he was seeing strong conversions from temporary to permanent status. One reason that some people were more pessimistic was that they believe the current expansion is a bit, as they say, long in the tooth, and so the economy must be due for a period of weakness. Of course, the economic literature finds that the probability of an expansion’s ending does not depend on the expansion’s current length. However, these comments could reflect imbalances in the economy that increase exposure to adverse shocks. But except for housing, any references to such imbalances are vague at best. Although it is not certain, the mixture of reports may simply be indicative of the normal process of the economy’s moderating to growth averaging near or a bit below potential. On the inflation front, we continue to hear reports of cost pass-through and other price increases similar to those we’ve received in recent months. Turning to the national outlook, although growth moderated in the second quarter, GDP growth for the first half was a solid 4 percent. The unemployment rate remains below 5 percent, and the core PCE inflation rate has now been at or above 2 percent for more than two years. It has to be said, in looking simply at the top-line data that form the basis of most Taylor rules, that real activity is pretty good and inflation is too high. In this context, three related questions guided my thinking on the outlook. First, are there important imbalances within particular sectors that should concern us? Second, is the list of exogenous downside shocks accumulating to a point that the risks to growth outweigh those from deteriorating inflation? Third, are the current financial conditions restrictive or not? Regarding sectoral imbalances, for some time we have assumed a marked slowdown in residential investment, but other sectors do not seem to be outside normal ranges of variation associated with an economy that is growing close to potential. Business fixed investment last quarter was weaker than we had thought, but the weakness appeared to largely reflect transitory developments in volatile categories—communication equipment and transportation. Importantly, we don’t hear any stories of pulling back due to earlier overinvestment. On the household side, the steady growth in the consumption of nondurables and services indicates that households do not seem to be overly concerned about their longer-term prospects for income growth. So for now, I do not see any sectoral imbalances that would pile on the housing adjustment and cause a more fundamental downshift in economic growth over the forecast period. What about shocks? Well, the list of downside shocks is troublesome. Energy prices continue to surprise us on the upside. Geopolitical risks have increased, particularly considering developments in the Middle East. We now have some sense from businesses that animal spirits may be making them more cautious. Currently, however, I think that this is more rhetoric than action. Still I think that all these factors deserve careful monitoring. Third, what about financial conditions? When I was preparing for this meeting, I talked to no one who thought that conditions are restrictive. The modal response continues to be that financing is readily available and is fueling a lot of dealmaking. Ten-year Treasury rates are under 5 percent. Risk spreads are low. If we want to assess the constraining effects of past increases in the federal funds rate, we need to take into account the level of interest rates. In all likelihood, the real funds rate has only recently reached neutral. Furthermore, we need to consider the accommodation that we had put in place in 2003 and 2004. The core PCE inflation data we now have for that period are about ½ percentage point higher than what we saw in the real-time initially announced inflation rates that guided our policy decisions back then. So the unwelcome disinflation of 2003 was not as severe as we had feared at the time, and accordingly, our policy was more accommodative than we thought at the time, which may have had inflationary consequences. The incoming data make the current inflation situation seem much more troublesome. First, as we all know, the latest reading on core PCE inflation is 2.4 percent. That’s pretty high. Second, the revised NIPA data indicate that core PCE inflation has been at or above 2 percent since April 2004, as President Poole mentioned. The combination of these two facts makes me more concerned that inflation expectations may soon begin to drift up. Finally, I don’t see the forces in play that would make the policy assumption in the Greenbook restrictive enough to put core inflation on a downward trajectory over the next 18 months. If the pass- through was small on the way up, it seems likely to be small on the way down, and output gaps that might be emerging will not alter inflation’s trajectories very much or very quickly with flat estimates of Phillips curves." FOMC20080805meeting--41 39,MR. WILCOX.," We don't quite understand why this sector seems to have resembled the cartoon character that keeps running along when we think there shouldn't be any support underneath it. [Laughter] We are staunchly negative about the second half for this sector, and that view is informed by the precipitous drop in the architectural billings index. That's one of the relatively few indicators that gives us any purchase on what's going to happen in this sector. It's a helpful indicator of spending about six months ahead. We think that financial conditions are pretty tough in this area. We're getting a lot of anecdotal evidence that people are having greater difficulty financing projects than was the case before, and we've seen some uptick in vacancy rates as well. So we think all of those are factors. I guess I would say that we've heard very persistently negative reports from our supervision colleagues as well about what's going on in that area. " CHRG-110shrg50409--77 Mr. Bernanke," Well, Senator, first, although I know it is not always easy to explain, our actions, as I said earlier, with respect to Bear Stearns, with respect to Fannie and Freddie, with respect to the financial system in general are based on our view that financial stability is critical to economic stability. I think the benefit is more obvious to the average person from Fannie and Freddie because they, after all, are providing liquidity for mortgages, and people want to be able to have access to mortgages. So I just do not accept the distinction between helping Wall Street and helping Main Street. The actions we have taken are aimed at supporting the overall economy and helping the average American. With respect to your question, I agree that there was a delay in recognition of this issue. Once we undertook it, though, we had to go through a regulatory process that involves developing regulations, putting them out for comment, re-evaluating them and so on. There is a natural period of time. I think that is probably a good thing in the sense that we want regulations to be well thought out and so on. But to the extent that Congress wants to act more quickly or is concerned about the constraints on the agency's powers given to them by their enabling legislation, Congress, of course, can act very quickly if they need to. Senator Brown. While I do not oppose your actions on what we are going to try to do with Fannie and Freddie, and I think we did what we had to do with Bear Stearns, I think there is a perception, and probably a reasonable perception, a deserved perception, that our Government, whether it is regulatory process or the Congress, is much more apt to move quickly on Wall Street when we do not move so quickly on Main Street. Granted, you had to go through a process, and as I say, I think you are refreshingly different from your predecessor. But what can you do to speed that up so the public really can be assured that while it does make sense for the economy as a whole, which helps everyone on Main Street, too, doing the right thing with Wall Street, but it is pretty clear that when--and the Bush administration really did not seem to think there was a subprime crisis until it spread to Wall Street. When it was just Main Street, Mansfield, and Main Street, Zanesville, it did not seem to be much of a problem. " CHRG-111shrg56376--36 Mr. Bowman," Thank you, sir. One of the advantages of being last on a panel like this is you usually get to agree and sort of dispel the notion that we disagree on so many things. I agree with what my colleagues have said, but I would also like to focus on the arbitrage position between banks and nonbanks. I think the CFPA provision of the Administration's bill goes a long ways toward dealing with that situation. The difference is that you don't get to sell a product at a nonregulated entity under different terms and conditions, a different regulatory structure, than you would if you were doing so in a depository institution or otherwise regulated entity. I think that is one of the critical components of this Administration's proposal to fix that gap. Senator Brown. Thank you. Thank you, Mr. Chairman. " CHRG-111hhrg56766--234 Mr. Green," Would you agree that one of the things that we might do is try to help those countries where they have people working for pennies per day that may not have labor standards that people of goodwill would agree with? We might also try to influence what they do if we trade with them. It would not cause me as a person, a human being, to feel good about an effort that would cause persons to work for pennies a day and allow me to benefit when they are working under conditions that are less than tolerable by my standards. " CHRG-111shrg50564--68 Mr. Volcker," The hole gets bigger. Senator Reed. In the G-30 report, the reported noted that credit rating agencies are not held legally accountable for their ratings. Do you believe that has to change? " FOMC20080318meeting--102 100,MR. MADIGAN.," 2 Thanks, Mr. Chairman. I will be referring to the revised version of table 1 distributed earlier today in the package labeled ""Material for FOMC Briefing on Monetary Policy Alternatives."" The revised table presents the same basic set of alternatives that was discussed in the Bluebook. However, we have proposed some changes in language that affect the statements for alternatives A and B. I will discuss those changes, shown in blue, shortly. Alternative D, presented in the right-hand column, would leave the federal funds rate unchanged at this meeting at 3 percent. Committee members might be inclined to favor this alternative if they were particularly concerned about prospects for inflation and if they believed that, with due allowance for lags, the monetary and fiscal stimulus in train would likely be sufficient to lead to a resumption of moderate growth over time. The wording of this alternative would acknowledge the downside risks to growth. But as shown in paragraph 3, the statement would indicate that inflation has been elevated, cite several factors that could put additional upward pressure on inflation, and state that the upside risks to inflation have increased. No net assessment of the balance of risks would be included. Under alternative C, the stance of policy would be eased by 25 basis points today. A modest easing of policy might be motivated by judgments that the economic outlook has weakened, but by appreciably less than in the Greenbook, and that the inflation outlook is troubling. Members might see financial strains as concerning but likely to exert less restraint on growth than in the Greenbook forecast. 2 The materials used by Mr. Madigan are appended to this transcript (appendix 2). In these circumstances, the Committee might want to be cautious about policy adjustments that could add impetus to inflation, particularly given the substantial easing of monetary policy to date and the lags in the effects of policy. The language proposed for alternative C would note that the tightening of credit conditions and the deepening of the housing correction are likely to continue to weigh on economic growth. The inflation paragraph for this alternative is the same as that for alternative D. As shown in paragraph 4, the Committee would make an explicit judgment that the downside risks to growth outweigh the upside risks to inflation. Under alternative B, the Committee would reduce the federal funds rate 50 basis points today, to 2� percent. Such an approach could be seen as consistent with the Greenbook forecast. Indeed, under that forecast, the Committee is assumed to ease policy 50 basis points at this meeting and another 75 basis points over the next three months. The motivation for such a trajectory is provided partly by the 1� percentage point downward revision to the Greenbook-consistent measure of short-run r*. The Committee might concur with the staff's assumption regarding the amount of cumulative easing that will eventually prove necessary and find a gradual shift in policy attractive, particularly in view of what seems to be some upward drift of late in inflation expectations. Such a path would also be qualitatively consistent with the optimal control simulations shown in the Bluebook for a 2 percent inflation target, in which the federal funds rate is eventually eased to around 1� percent. As shown in paragraph 2, the statement issued under this alternative would indicate that the outlook had weakened. We have suggested striking the reference to risks as that thought is picked up in the risk assessment. The statement would go on to mention several factors that could weigh on economic growth, and we have suggested adding ""over the next few quarters."" With regard to inflation, the Committee would note that inflation has been elevated. It would also indicate an expectation that inflation will moderate in coming months and cite several factors that could contribute to that moderation but note that uncertainty about the inflation outlook has increased. Notably, the list does not mention ""reasonably well anchored inflation expectations"" or some variant of that phrase, which has been used recently in the minutes and other policy communications. Indeed, the first sentence of the paragraph notes that some indicators of inflation expectations have risen. Partly because inflation compensation includes a premium for inflation risk as well as inflation expectations, we thought that ""indicators"" of inflation expectations might be a better word than ""measures"" and have suggested that substitution. Over the past few days, inflation compensation as read from TIPS has plunged; however, we are skeptical that the decline represents primarily a drop in inflation expectations or inflation risk. Rather, we suspect that it is importantly a result of shifting liquidity premiums, as yields on nominal Treasury securities have fallen sharply partly because of increased demands for safety and liquidity. The final paragraph of alternative B would repeat the risk assessment issued after the January meeting. It would again indicate that downside risks remain and emphasize that the Committee will act in a timely manner to address those risks. Finally, under alternative A the Committee would lower the funds rate 75 basis points today. Given the extent of policy easing assumed in the staff forecast, this alternative could easily be consistent with an outlook along the lines of the Greenbook. This policy approach could also be motivated by concern about the possible implications for the economic outlook of the worsening in financial market conditions in the five days since the staff forecast was finalized or by a riskmanagement approach that gave particular weight to the downside risks around the outlook. The language proposed for the rationale section, paragraphs 2 and 3, of alternative A is identical to that proposed for alternative B. As with alternative B, the risk assessment paragraph says that policy actions should promote moderate growth over time and mitigate downside risks, but this version also alludes to the measures that the Federal Reserve has implemented to promote market liquidity. This language could also be used in alternative B. Rather than providing an assessment of the balance of risks, as we did in the Bluebook version, here in alterative A we have suggested simply indicating that downside risks to growth remain. Given the high degree of uncertainty, you might again prefer not to make an overall risk assessment. This paragraph differs from the corresponding part of the January statement also by indicating that the Committee will act in a timely manner as needed to promote sustainable economic growth and price stability. Thus, while the Committee eases 75 basis points, this language of alternative A would signal some increase in the Committee's concern about inflation in several ways: by indicating that inflation has been elevated; by noting that some indicators of inflation expectations have risen; and by incorporating a traditional formulation of the dual objectives, including price stability, in the final sentence. As Bill noted this morning, market participants appear to place substantial odds on a 100 basis point policy move at this meeting. Thus, implementation of any of these alternatives would involve at least somewhat less easing than expected. Given what would appear to be very fragile market conditions and highly skittish investor sentiment, you might see somewhat greater risks than usual in diverging from market expectations, and obviously the risks would be larger the greater the gap between anticipation and your actions. At the same time, you might see good reasons for some divergence. First and most obviously, you might see a smaller move as appropriately calibrated given your outlook and sense of the risks. Also, some indicators do seem to suggest that inflation expectations have become a bit less firmly moored. Even if you see gradual dollar depreciation as likely to be appropriate given the weakness of the U.S. economy and quite possibly a necessary factor in fostering an improved current account balance over time, you may be concerned about the downward lurch in the dollar over recent days and the potential for disorderly conditions to develop. You may judge that a policy decision today to implement somewhat less easing than markets expect and a statement that implies somewhat greater concern about inflation could be helpful in leaning against inflation expectations and any sense in markets that you are indifferent to downward pressure on the dollar. Alternative A would likely prompt some increase in shorter-term interest rates; but given that the risk assessment would point to continued downside risks, market participants would infer that further easing is a likely prospect, and the effects on other financial asset prices and financial conditions more generally could be reasonably limited. The 50 basis point easing of alternative B, in contrast, would suggest to market participants that you are inclined to be considerably more cautious in easing policy further, even with the downside risk assessment, and short- and intermediate-term interest rates could ratchet considerably higher, equity prices decline, and credit conditions tighten--responses that presumably would be amplified, perhaps nonlinearly, under alternatives C and D. " FOMC20081216meeting--86 84,MR. ROSENGREN.," I would also like to join the chorus of people thanking the staff, in particular the staff members who were working on the memos on Japan. Having done some work on Japan myself, I know that getting the institutional details right is far from easy, particularly when you are not a native speaker. So I much appreciated the work in that area. The probability of a severe economic downturn accompanied by deflation is too high, and the effective fed funds rate is already very close to zero. This combination calls for aggressive, nontraditional policies. My reading of the parallel Japanese experience highlights two general principles. The first is one that President Stern highlighted. There is a macroeconomic impact from what we do in bank supervision. Banking problems should be addressed expeditiously, with realistic write-downs of problem assets and recapitalization of problem banks. In particular, we should prevent perverse incentives where problem borrowers are supported while healthier borrowers are starved for credit as banks try to satisfy balance sheet constraints and avoid further loss recognition. Second, monetary and macroeconomic policies to address financial dislocations should be proactive and forceful rather than released gradually over an extended period of time. In the context of the questions that we have been asked to address, I'd like to encourage us to take three actions. First, I would explicitly state that the Committee seeks to achieve a core PCE inflation rate of 2 percent in the medium term. For the second time this decade we are approaching the zero nominal interest rate bound. Setting too low an inflation target threatens to place us in our current predicament too often. In contrast, by setting an explicit target at 2 percent, we will indicate our resolve to take nontraditional policies necessary to achieve that goal. Because the inflation target adopted under the current circumstances would be designed to raise inflation expectations and stimulate the economy, this may be a particularly propitious time to adopt such an explicit target. A 2 percent target would also be consistent with our own revealed preference as the core PCE inflation rate has averaged 1.94 percent, very close to 2 percent, over the past ten years. Second, during the past recession, 30-year conventional mortgage rates reached 5� percent. The current rate has been hovering at 5� percent and has reached that level only since we announced our program to purchase $600 billion in GSE debt and mortgage-backed securities. The housing sector remains the epicenter of our problems. Given the current outlook, I would suggest using facilities to move toward an interest rate target, for example, by reducing by 100 basis points from current levels the conventional 30-year mortgage rate. Lowering the 30-year conventional mortgage rate would reduce the cost of purchasing new homes, encourage refinancing by those with sufficiently high credit scores and equity in their homes, and support fiscal policies that are targeted at more-troubled homebuyers. It would help troubled and healthy homeowners, stimulate the most distressed area of our economy, and help financial institutions exposed to problems in housing. Such a target would be understandable to the general public, and actions already taken have made some progress in this area and serve as an example. I would focus on the mortgage rates rather than the Treasury yield curve because lower Treasury rates seem to be having little effect on rates paid by households and businesses, and the desire to avoid credit risk has already brought 10-year Treasury rates to lows not seen in most recent recessions. Third, our facilities for short-term credit have been successful. Short-term commercial paper rates have fallen as a result of our programs, as was highlighted by Bill Dudley, and the rollover risk at the end of the year has been mitigated by the commercial paper program. Increasingly, however, I have been hearing complaints about banks pulling lines of credit when they are up for renewal primarily because the banks are facing balance sheet issues. One possible remedy might be to extend our commercial paper facility to highly rated firms for longer maturities than are covered by the commercial paper market. All three suggestions would be easily communicated and understood by the public, would address directly the areas of the economy in which financing has become particularly difficult, and would highlight our resolve to avoid a deflationary economy, such as Japan experienced for over a decade. I would just end with the note that I agree with the Governor Kohn on the monetary base for two reasons. The first is that I do not think our facilities have been particularly well designed to set a quantitative target. Many of the facilities are open ended. Go through the following thought experiment. Suppose a money market fund once again breaks the buck. The AMLF will probably go up $150 billion or $200 billion. I would expect the commercial paper facility to go up. I would expect that most of the bank facilities would also go up. If we were limited by a quantitative target at the very time that we actually want those facilities to be expanding, we would be constrained. I do not think that is a good idea in the current situation. The second reason comes from my reading of what happened in Japan, and this goes to some of the remarks that the Chairman made. The monetary base in Japan did expand very rapidly. When banks are capital constrained, expanding reserves very rapidly does not translate into an expansion of the broader balance sheet. So we could very easily see a situation in the United States in which banks continue to be capital constrained for some time. Despite increasing the monetary base, we might not see an expansion in terms of other assets. That is exactly why I agree with the Chairman that we should be focused on the asset, not the liability, side of the balance sheet. " CHRG-111shrg56376--33 Chairman Dodd," Thank you very much. Senator Brown. Senator Brown. Thank you. I was a little surprised by Senator Shelby's question, considering the positions that you have all taken. Let me look at this in kind of a different way. The public has a general understanding. The investing public and the victims of this financial disaster, which is my whole State and most of this country, has a general understanding that regulation of financial institutions, putting it mildly, fell far short. Some have the belief that the most, I think the most egregious institutions found an agency that was too easy on them. In Washington, we call that regulator shopping. They just think that the Government, for whatever reason, was too easy on Wall Street greed. And I hear each of you. There may be some turf issues, and that may be a cynical way to look at it and I apologize if that is the way you take it, but I hear the--I see the President's plan, the President's proposed bank supervision framework. I hear each of you disputing major parts of it. How would you explain to the American public what the next step is? How do we fill the financial gaps in our financial regulatory system if consolidation of regulators is not the best move? How do you explain to the public why four very smart people playing very important roles in our financial institution regulatory system and an Administration that, I think, has equally smart people that understand this, why is there not more agreement? How do you explain in understandable terms, if you were talking directly to the American people now, not to this Committee, what we should do to fill these gaps so these kinds of egregious, awful things don't happen again? I will start with you, Ms. Bair. Ms. Bair. Well, I think there was arbitrage, but it was between the bank and the nonbank sectors. It was excess leverage with investment banks and hedge funds and other types of vehicles versus the higher leverage in risk-based capital requirements that we had for commercial banks. On consumer protection, it was third-party mortgage originators that were not affiliated with insured depository institutions originating loans being funded by Wall Street funding vehicles. The third-party mortgage originators were pretty much outside of any type of prudential or consumer protection standards that were within the purview of the banking regulators. So I think it is unfortunate the word ``bank'' is used for just about every institution, but in my world, a bank is an FDIC-insured institution. While we all made mistakes, the insured depository institution sector has held up pretty well. This is why you saw in December so many financial companies fleeing to become bank holding companies and trying to grow their insured institutions, because that was the sector that was left standing, which is hard for the FDIC because our exposure has increased significantly. We have tried to do the things we need to do to stabilize the system. But, this has increased our exposure significantly. As I have testified before, the arbitrage is between the banks and the nonbanks. Having a consumer agency with a focus especially on examination and enforcement of the nonbank sector and having a Systemic Risk Council that would have the authority to define systemic issues or systemic institutions, whether or not they voluntarily want to come in under the more stringent regulatory regime we have for banks and bank holding companies. The arbitrage was between the bank and the nonbank sectors. It was not among different types of bank charters, and certainly not between the choice of a State or Federal charter. There are 8,000 community banks in this country. Most of them have a State charter, so consequently, we regulate about 5,000 banks. I don't think they contributed to this, but you have seen traditional resistance among community banks to regulatory consolidation for fear, frankly, which I share, that inevitably there would be a regulatory viewpoint that would be dominated by the larger institutions if everyone was lumped in together. There is a valid reason for State charters. The community banks and State-chartered community banks tend to be more local in their interest and how they conduct their lending. To try to draw that issue into the much larger problems we had with arbitrage between banks and nonbanks and then the lack of regulation of derivatives, I think, is misguided and is not where you should be focusing your efforts or the American public should be focusing its efforts. Senator Brown. Mr. Dugan, your thoughts? " FinancialCrisisReport--313 In September 2007, Moody’s solicited industry feedback on proposed enhancements to its evaluation of nonprime RMBS securitizations, including the need for third-party due diligence reviews of the loans in a securitization. Moody’s wrote: “To improve the accuracy of loan information upon which it relies, Moody’s will look for additional oversight by a qualified third party.” 1219 In November 2008, Moody’s issued a report detailing its enhanced approach to RMBS originator assessments. 1220 E. Preventing Inflated Credit Ratings Weak credit rating agency performance has long been a source of concern to financial regulators. Many investors rely on credit ratings to identify “safe” investments. Many regulated financial institutions, including banks, broker-dealers, insurance companies, pension funds, mutual funds, money market funds, and others have been required to operate under restrictions related to their purchase of “investment grade” versus “noninvestment grade” financial instruments. When credit agencies issue inaccurate credit ratings, both retail investors and regulated financial institutions may mistakenly purchase financial instruments that are riskier than they intended or are permitted to buy. The recent financial crisis has demonstrated how the unintended purchase of high risk financial products by multiple investors and financial institutions can create systemic risk and endanger, not only U.S. financial markets, but the entire U.S. economy. (1) Past Credit Rating Agency Oversight Even before the recent financial crisis, the SEC and Congress had been reviewing the need for increased regulatory oversight of the credit rating industry. In 1994, for example, the SEC “issued a Concept Release soliciting public comment on the appropriate role of ratings in the federal securities laws, and the need to establish formal procedures for recognizing and monitoring the activities of [credit rating agencies].” 1221 In 2002, the Senate Committee on Governmental Affairs examined the collapse of the Enron Corporation, focusing in part on how the credit rating agencies assigned investment grade credit ratings to the company “until a mere four days before Enron declared bankruptcy.” 1222 The Committee issued a report finding, among other things, that the credit rating agencies: 1219 “Moody’s Proposes Enhancements to Non-Prime RMBS Securitization,” Moody’s (9/25/2007). 1220 “Moody’s Enhanced Approach to Originator Assessments for U.S. Residential Mortgage Backed Securities (RMBS),” Moody’s, Hearing Exhibit 4/23-106 (originally issued 11/24/2008 but due to minor changes was republished on 10/5/2009). 1221 1/2003 “Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets,” prepared by the SEC, at 5. 1222 10/8/2002 “Financial Oversight of Enron: The SEC and Private-Sector Watchdogs,” prepared by the U.S. Senate Committee on Governmental Affairs, at 6. See also “Rating the Raters: Enron and the Credit Rating Agencies,” before the U.S. Senate Committee on Governmental Affairs, S.Hrg. 107-471 (3/20/2002). The Committee has since been renamed as the Committee on Homeland Security and Governmental Affairs. “failed to detect Enron’s problems – or take sufficiently seriously the problems they were aware of – until it was too late because they did not exercise the proper diligence. … [T]he agencies did not perform a thorough analysis of Enron’s public filings; did not pay appropriate attention to allegations of financial fraud; and repeatedly took company officials at their word … despite indications that the company had misled the rating agencies in the past.” 1223 CHRG-111shrg50814--206 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM BEN S. BERNANKEQ.1. The Federal Reserve announced the creation of a $200 billion Term Asset-Backed Securities Loan Facility in November 2008. Just 2 weeks ago, the Federal Reserve in conjunction with the Treasury Department, announced the expansion of the program to up to $1 trillion and the possible expansion of eligible collateral. Given that we have not yet seen the first part of the program be an operational success, why did the Federal Reserve feel that it was necessary to announce an expansion of both volume and scope? Why should we be convinced that this program is the most effective mechanism to unthaw securitization markets? Do we have a true understanding of why investors have pulled away to the degree they have? And if we don't know the reason, then how can we expect to design an appropriate remedy?A.1. The Term Asset-Backed Securities Loan Facility (TALF) was initially announced on November 25, 2008. In its initial stage, eligible collateral for TALF loans included AAA-rated newly issued asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, and Small Business Administration (SBA) guaranteed loan. The first TALF operation took place on March 17, 2009. The 4 months between announcement and operation reflected in part the time necessary to design the operational infrastructure of the program, but during that period the Federal Reserve also consulted with investors, issuers, and rating agencies about the asset classes included as eligible collateral as we developed the specific terms and conditions for the program. The initial set of eligible collateral was chosen with a view toward increasing the availability of credit to small businesses and households. The initial $200 billion ceiling for the program reflected our estimate of the likely activity with the approved collateral list over the announced period of operation--through December 31, 2009. The dysfunction in the asset-backed securities markets has had adverse effects on credit markets other than those for consumer and small business credit. For example, secondary markets for securities backed by commercial and nonconforming residential mortgages have been experiencing severe strain, and the availability of other certain types of business credit that has often been securitized in the past has diminished greatly. The announced expansion of the program is intended to facilitate issuance of securities backed by loans to those other sectors. We recognized that in order to accommodate the potential lending against the broader set of collateral, an increase in the overall size of the facility could be necessary. The announcement of the expansion preceded the first initial operation because of the urgency of encouraging lending to these other sectors. Our announcement that consideration was being given to expanding the facility likely provided some additional support, at the margin, for the residential and commercial mortgage-backed securities markets. Also, given the considerable lead time that it takes to develop terms and conditions for each asset class that both encourage ABS issuance and protect the taxpayer, it was important to announce the possible expansions as quickly as possible. The abrupt decline in new issuance of ABS reflected in large part two developments. First, the availability of leverage to ABS investors has contracted significantly because of the balance-sheet constraints now being faced by many major banking firms. Second, many traditional investors in AAA tranches of ABS have exited the market because of concern about the possibility of a severe recession and a sharp rise in defaults on loans to business and households. The TALF provides leverage to encourage new investors to purchase ABS. In addition, because the loans are provided on a non-recourse basis, the facility limits the potential losses of the investors to the amount by which the value of the ABS financed by the TALF loan exceeded the loan amount (the haircut). Although those haircuts have been chosen to reduce to only negligible levels the odds that the government will incur a loss on the facility overall, the program provides a degree of downside protection for investors on each asset financed.Q.2. According to information already released, the Term Asset-Backed Securities Lending Facility (TALF) will only accept newly originated assets and would require the credit rating agencies to rate the underlying securities. This system seems to attempt to mirror the general structure of the securitization market. There is concern, however, that the same credit rating agencies who were responsible for placing a ``AAA'' rating on now toxic structured products will be relied on once again to rate these securities. What steps is the Federal Reserve taking to ensure that underlying assets are appropriately underwritten? Is the Fed prepared to dictate the terms to ensure that these loans, at minimum, comply with federal underwriting guidelines?A.2. The Federal Reserve has discussed with the rating agencies the methodologies that they follow to rate the ABS accepted as collateral at the program. In general, rating agencies have taken steps that have led to tighter underwriting standards and stricter ratings criteria. In addition, the Federal Reserve requires that each ABS issuer hire an external auditor that must provide an opinion, using examination standards, that management's assertions concerning key collateral eligibility requirements are fairly stated in all material respect. TALF investors also serve an important ongoing role in price discovery and assessing risk through their ability to demand greater credit enhancements or price concessions. In particular, the sale of securities through TALF in an arms-length transaction is an independent check not only on the underwriting practices of the issuer, but also of the efficacy of rating agency methodologies. There are no Federal underwriting standards for the loans backing the collateral accepted at the TALF. The TALF does not currently accept collateral backed by home mortgages. If residential mortgage-backed securities were to become eligible collateral for the TALF, we would require that the loans backing the securities comply with Federal underwriting standards.Q.3. Your testimony notes that the United States has no well-specified set of rules for dealing with the potential failure of a systemically critical non-depository financial institution. I would agree that we need to address the too-big-to-fail issue, both for banks and other financial institutions. You have suggested the need for a resolution regime that allows the government to have a pre-defined process for resolving a non-bank financial firm that is systemically critical. Are you suggesting that non-bank financial firms must be dealt with in a manner other than changes to the bankruptcy process; that is, do we have to go to a receiver-like approach similar to FDIC? If so, how do we deal with the moral hazard implications? If not, what are other tools we could look at to address the current lack of resolution regime?A.3. Although the Bankruptcy Code works well in the vast majority of situations, it is not designed to mitigate systemic consequences and, in some cases, the bankruptcy process may exacerbate the shocks to the financial system that may result from the failure of a systemically important nonbank financial institution. For example, the delays in the bankruptcy process that are designed to give the debtor ``breathing room'' to develop and propose a reorganization plan can be especially harmful to financial firms because uncertainty with respect to any large financial firm can have negative consequences for financial markets which are compounded as the uncertainty persists. In addition, the bankruptcy process does not currently provide a clear mechanism for the government to ensure that the institution is resolved in a way that achieves financial market stability and limits costs to taxpayers. Congress has in the past established alternative resolution regimes outside of the Bankruptcy Code for financial institutions where the public has a strong interest in managing and ensuring an orderly resolution process, such as in the Federal Deposit Insurance Act for insured depository institutions and in the Housing and Economic Recovery Act for government-sponsored enterprises. As I have indicated, these frameworks can serve as a useful model for developing a framework for the resolution of systemically important nonbank financial institutions. The issue of moral hazard is an extremely important consideration in developing any such regime for resolving systemically important nonbank financial institutions. Any proposed regime must carefully balance the need for swift and comprehensive government action to avoid systemic risk against the need to avoid creating moral hazard on the part of the large institutions that would be subject to the regime. A proposed regime could require a very high standard for invoking the resolution authority, because of the potential cost and to mitigate moral hazard. The process to invoke the authority could also include appropriate checks and balances, including input from multiple parts of the government, to ensure that it is invoked only when necessary while still maintaining the ability to act swiftly when needed to minimize systemic risk. The systemic risk exception to the least-cost resolution requirements of the Federal Deposit Insurance Act could provide a good example of the embodiment of such a process in existing law. Importantly, the establishment of a new resolution process for systemically important nonbank financial institutions may help reduce moral hazard by providing the government with the tools needed to resolve even the largest financial institutions in a way that both addresses systemic risks and allows the government to impose haircuts on creditors in appropriate circumstances. While a new framework for systemically important nonbank financial institutions is a critical component of any agenda to address systemic risk and the too-big-to-fail problem, other steps also need to be taken to address these issues. These include ensuring that all systemically important nonbank financial institutions are subject to a robust framework for consolidated supervision; strengthening the financial infrastructure; and providing the Federal Reserve explicit authority to oversee systemically important payment, clearing and settlement systems for prudential purposes.Q.4. The Obama administration, along with several of my colleagues here in the Senate, have proposed allowing bankruptcy judges to cramdown the value of mortgages to reflect declines in home prices. The Federal Reserve, primarily through its purchases of GSE MBS, is becoming one of the largest holders of residential MBS. Has the Federal Reserve estimated the size of potential losses to the Fed's MBS holdings, if judges were allowed to cramdown mortgages? What signal do you believe this sends to potential investors in MBS, were Congress to re-write the contractual environment underlying these mortgages?A.4. As noted by your question, the vast majority of mortgage-backed securities (MBS) held by the Federal Reserve are agency MBS. The payment of principal and interest on agency MBS is guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. Bankruptcy cramdowns do not affect investors in MBS guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae because the agency MBS investors would be made whole by the government-sponsored enterprises. Thus, the Federal Reserve holdings of agency MBS would not be affected by bankruptcy cramdowns for mortgages, although such legislation might have negative consequences for Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA). (The FHA insures the mortgages securitized by Ginnie Mae.) Private-label MBS are governed by trust agreements. Some private-label MBS contain so-called ``bankruptcy carve-out'' provisions requiring that losses stemming from bankruptcies be shared across the different tranches of the securities. The implication is that the investors holding the AAA-rated tranches would bear some of the losses from these principal write-downs, depending on the nature of the trusts agreements. The Federal Reserve has made loans to support its Maiden Lane Facilities, which were used to offset the systemic risks associated with recent financial market disruptions. Among the collateral for these loans are AAA-rated tranches of private-label securities, as well as some collateralized debt obligations (CDOs) that are backed by AAA-rated tranches of private-label securities. At present, our assessment is that the possible loss associated with these MBS holdings from possible bankruptcy cramdown legislation is relatively small. With respect to current mortgage borrowers, providing bankruptcy judges with the ability to adjust mortgage terms and reduce outstanding principal could potentially result in more sustainable mortgage obligations for some borrowers and thus help reduce preventable foreclosures. Such an approach has several advantages. In particular, because of the costs and stigma of filing for bankruptcy, mortgage borrowers who do not need help may be unlikely to turn to the bankruptcy system for relief. In addition, bankruptcy judges may also be able to assess the extent to which a borrower truly needs assistance. Moreover, because the bankruptcy system is already in place, this approach could be implemented with little financial outlay from the taxpayer. Whether mortgage cramdowns are advantageous in the long-run is less clear. Such cramdowns could potentially restrict access to mortgage credit for some borrowers, and might have implications for investors in other types of loans because of the change in the loan's relative status during the course of bankruptcy. Potential investors, either in private-label MBS investors or in other types of loans, might view these changes in the bankruptcy code as raising the costs associated with servicing defaulted borrowers in the future if investors perceived such changes as permanent and broad-ranging, or if these changes altered investors' expectations about the government's willingness to make similar changes in the future. In this case, mortgage cramdowns might have longer-lasting effects on credit availability, and possibly impose higher costs on future borrowers through higher interest rates and more stringent lending standards.Q.5. In a recent speech, you stated that the Fed's new longer-term projections of inflation should be interpreted as the rate of inflation that FOMC participants believe will promote maximum sustainable employment and reasonable price stability. Some commentators have said that central banks using a long-term inflation target should incorporate the adverse consequences of asset-price bubbles in their deliberations. Does the FOMC presently incorporate the possibility of asset price bubbles during deliberations on the inflation target? Did the FOMC include asset price bubbles in past deliberations?A.5. Conditions in financial markets, including the possibility that asset prices exceed fundamental values, are always discussed at FOMC meetings. High asset values tend to put upward pressure on economic activity and the broader price level. In order to achieve its mandated objectives, the FOMC may need to tighten policy when this pressure threatens to push inflation above desired levels. However, it is exceedingly difficult to judge in real time whether asset prices are deviating from their fundamental values. Indeed, if such a judgment were easy, bubbles would never happen. However, regardless of whether a bubble exists or not, the FOMC does factor in the effects of asset prices on the economy when it sets monetary policy. Generally speaking, this means that interest rates tend to rise when asset prices are increasing to offset the inflationary impact of high asset prices and that interest rates tend to fall after bubbles burst to offset the contractionary effects of falling asset prices on employment.Q.6. I have some concerns about the pro-cyclicality of our present system of accounting and bank capital regulation. Some commentators have endorsed a concept requiring banks to hold more capital when good conditions prevail, and then allow banks to temporarily hold less capital in order to not restrict access to credit during a downturn. Advocates of this system believe that counter cyclical policies could reduce imbalances within financial markets and smooth the credit cycle itself. What do you see as the costs and benefits of adopting a more counter cyclical system of regulation? Do you see any circumstances under which the Federal Reserve would take a position on the merits of counter cyclical regulatory policy?A.6. The Federal Reserve has long advocated the need for banks to maintain sufficient levels of capital so they can weather unexpected shocks without interrupting the provision of credit and other financial services to customers. Historically, the challenge has been translating this broad principle into regulatory and supervisory standards that are workable, balanced, and compatible with a level, competitive playing field, both domestically and internationally. Capital is a relatively costly source of funding for banks, and higher capital requirements for banks will tend to raise their costs relative to those of competitors. Against this cost, there is a need to balance the benefits of higher capital in terms of lower risk to the safety net and enhanced financial and economic stability. However, these benefits are more uncertain and difficult to quantify. Likewise, while most would agree that a bank should maintain capital commensurate with its underlying risk taking, the quantification of risk is imprecise and inherently subjective. There is also uncertainty regarding how financial markets would react to changes in the capital framework and, in particular, whether higher capital buffers accumulated in good times would simply result in higher de facto minimum standards during downturns. In the past, it has been difficult reaching agreement on major changes to the bank capital framework, reflecting different views on how best to deal with these uncertainties (e.g., Pillar 1 versus Pillar 2 versus Pillar 3; hardwired formulas versus discretion; simple rules-of-thumb versus sophisticated risk models). Nevertheless, an international consensus appears to be emerging that the bank regulatory capital framework needs to be made more counter-cyclical, and such an initiative is currently being undertaken by the Basel Committee on Banking Supervision and Regulation. The Federal Reserve strongly supports and is actively involved in this initiative. While this effort faces many of the same challenges noted above, there is now greater appreciation of both the importance of promoting more counter-cyclical capital policies at banks and, we believe, the need to find a workable way forward on this issue. The Federal Reserve also supports initiatives currently under way at the Financial Accounting Standards Board and the International Accounting Standards Board (consistent with the recommendations of the Financial Stability Forum, now Financial Stability Board) to consider improvements to loan loss provisioning standards. These improvements would consider a broader range of credit quality information over the economic cycle to recognize losses earlier in the cycle. Similar to the requirements for capital buffers, the requirements for provisions would need to be set at a practical level and calculated in a readily transparent manner. Ideally, the requirement would need to be applied internationally to have the desired effect. In addition, enhancements to the income tax code to allow greater deductibility of provisions in line with the accounting treatment would also aid in this effort. ------ CHRG-111hhrg58044--189 Mr. Baca," Thank you very much, Mr. Chairman. I thank you and the ranking member for your leadership on this issue which is important to a lot of us, especially as we represent diverse groups of individuals within our communities. I am concerned from both aspects that it impacts everyone but also how it impacts many minorities as we look at the credit rating. I heard a lot of you talk about it when Congressman Moore said we needed more financial literacy. The problem is on this literacy, where does it go and what kind of outreach are we doing in making sure that when we target it, the different diversities, that they are actually aware of the credit scores that they are going to get, and if they get it, when do they know they are getting a credit score? Right now, as we look at its impact, it is not only on the automobile but also as we look at the health bill that is coming before us. Maybe any one of you three can explain that, and since no one has clearly explained the casual connection between credit scores and insurance risks, are customers at least made aware of the credit scores that are used when they purchase that coverage? Is there an adjustment during any period of time to their rates they are getting because they may have improved or something may not have been accurate during that period of time that the credit report went out, but yet you underwrote your insurance policy or health coverage, which means they are paying a higher premium. Another question: I am going to try to get all my questions in all at once. What effect does it have on our seniors? A lot of our seniors right now, when you look at their credit ratings, a lot of them get their checks once a month, there are adjustments in there, and then the ratings are there. Do we have any studies on the impact on a lot of our seniors? What are their rates compared to someone elses? How are we doing it in terms of geographical areas on the credit scores? People who live within certain geographical areas get a higher score versus individuals who do not live in those geographical areas, based on the high risk? Therefore, their premiums are a lot higher, yet their income does not change, but they are being impacted. When does the insurance company review the credit scores, after the initial purpose, or do they make adjustments in the ratings at one period or another, so this way the rates can also be lowered? If there are two individuals who get a credit score, husband and wife, say one or the other gets a higher score than the other. How is it underwritten, based on whom? The higher score or the lower score, or is there an adjustment in between? All three of you can tackle all of these questions. " CHRG-111hhrg48868--254 Mr. Polakoff," The timeline that you offered revealed that these contracts were initiated when this company was an operating--still well-rated company before any government funds. And we would have looked at the financial condition of the company as still a well-rated company with no taxpayer dollars in looking at those payments and the intent of those payments to keep employees at FP to unwind the transactions that originated in 2005 or earlier. " FOMC20080724confcall--110 108,MR. ALVAREZ.," I think you have all received the resolution. It is the second resolution on the third page. ""The FOMC extends until January 30, 2009, its authorizations for the Federal Reserve Bank of New York to engage in transactions with primary dealers through the Term Securities Lending Facility, subject to the same collateral, interest rate, and other conditions previously established by the Committee."" " CHRG-110hhrg46595--535 Mr. Friedman," Well, I think one of the flaws with that plan is, if you looked in the companies' plans, they are already depending--they are already expecting that money as part of their recovery plans. So maybe there is an argument--in fact, I think there is an argument--to find ways to accelerate getting them that money under some of the same conditions they were already going get the money, such as a 25 percent improvement in fuel economy. But they need additional money is what they are asking for. They are already expecting that money. " FOMC20081029meeting--113 111,MR. SHEETS.," Mexico is experiencing increased financial stresses, particularly in its corporate sector, where recently some bad bets on structured finance products have emerged, and Ortiz was very concerned about continued confidence in the Mexican economy. Now, that said, from what he had to say, dollar funding pressures had not yet emerged, and he was emphatic that they would not draw on these until the time that those funding pressures emerged or until the time that they saw a significant further deterioration in conditions in their economy. He was very specific about the fact that they would use their own reserves as their first, second, and third lines of defense. " CHRG-110shrg50420--103 Mr. Dodaro," That is a very good question, Senator, and I think that would be one area we would look to the board to establish based on looking at the financial condition and operating plan of the boards. I don't think that the schedule should be set by the borrower, which in this case you have your opening bid here as to when they would repay it. I think the schedule ought to be set by the lender, and that is one of the things the board should do. Senator Tester. That being said, you saw the repayment schedule that the auto manufacturers have put forth. At first blush, do you consider those repayment schedules realistic considering the economy we are in? " FOMC20080318meeting--59 57,MS. PIANALTO.," Thank you, Mr. Chairman. Through my conversations with people in the Fourth District financial community, I get the clear impression that some credit channels are closing down. Given the uncertainties in financial markets, some of the large banks in my District are finding it challenging to ascertain potential loss exposures in certain asset categories, especially to residential real estate developers. Two large banks in the District have seen their asset quality deteriorate more quickly than they had projected in January. Clearly, banks and other financial institutions are getting squeezed from both sides of their balance sheets, and the most highly leveraged institutions are getting squeezed the hardest. Many of the large banks in my District are going to considerable lengths to stay liquid and to conserve capital. The largest and most complex institutions are attempting to raise more capital. The deteriorating environment in the financial markets is clearly affecting business conditions. Most manufacturers in the District have seen a slowing in business activity. Those that are doing better are doing so because they are being helped some by stronger export demand. Pessimism over economic prospects is now prevalent among the CEOs that I talked with, and many are scaling back their business plans for 2008 by a considerable amount. The faltering business prospects are making the financial environment even more uncertain--a pattern that conforms to the adverse feedback loop that Governor Mishkin and others have been warning about. Like others, I have once more cut my growth projections for 2008 and, again, by a relatively large margin. As in the Greenbook, I have factored into my projection the weaker than previously expected estimates of spending and employment as well as the sharp run-up in energy costs. An especially important element in my current thinking is the future path of housing values. Many of my contacts have told me that they don't see how financial market conditions can stabilize without more confidence about where the bottom of the housing market lies and, as a corollary, where the bottom of the residential-mortgage-backed security prices might lie. Unfortunately, I haven't seen evidence that we are seeing a leveling out in housing prices. The Greenbook baseline projection carries with it nominal house-price declines of about 5 percent this year and next. A month ago that may have seemed like a reasonably good assumption to me, but today I fear that projection may be too optimistic. Certainly, the decline in house values that one sees in futures markets for the markets that are covered by the Case-Shiller index indicates a decline of twice that magnitude. My own baseline projection is closer to the ""greater housing correction"" alternative than the Greenbook's baseline projection. Even the ""greater housing correction with more financial fallout"" alternative seems somewhat plausible to me. Turning to the inflation outlook, at our January meeting my modal outlook was one in which the inflation trend declined to just below 2 percent in 2010. At the same time, I was one of the few participants who said that the inflation risk had shifted to the upside. I still hold to those views--that is, I still expect the trend of inflation to fall below 2 percent by 2010, but I still worry that we are going to continue to experience upside surprises to that inflation outlook. Indeed, I can't recall a single conversation that I have had with my business contacts recently that hasn't touched on the increasing cost pressures that they are facing. In most cases, they are now successfully passing along price increases to their customers. Nevertheless, as I assess the economic environment this morning relative to where I was in January, particularly given the prospects of yet larger wealth losses stemming from the real estate market and certainly the chance for even greater impairment to the functioning of our credit markets, I think the downside risks to economic growth continue to outweigh the upside risks to inflation. Thank you, Mr. Chairman. " FOMC20081216meeting--82 80,MR. KOHN.," Thank you, Mr. Chairman. I want to join the others in thanking the staff for their work. These are very difficult issues, and I think you have brought to bear a lot of what little information we have on these subjects and have kind of kept me out of trouble for the last week. My wife thanks you as well. [Laughter] I think the questions in the first set are largely moot, as a number of people have said. We are already close to the zero bound, and because I think moving there aggressively under the current circumstances is the right thing to do, I don't have any regrets about that. Like President Yellen, I came into this situation, at least a couple of months ago, wondering why zero wasn't the right lower bound. I recognize the market issues that might obtain--sort of as President Bullard said, I wonder whether markets won't adjust as we go on--but so close to zero, the difference between 6� basis points and zero isn't going to matter very much. But I think we ought to keep our eye on how markets are functioning, whether they adjust, and where we should be. Now, once we are at a minimum--and I think we ought to get wherever we are going at this meeting, as soon as possible (a number of people have said that, and I agree)--we can't influence actual expected short-term rates with our actions. We do need to rely on other methods to change relative asset prices--longer-term rates relative to short-term rates, private rates relative to government rates, nominal rates relative to expected inflation--and that is where the communications and the size and the composition of the asset portfolio come in. Both the communications and the portfolio actions can be effective and influential, but I think we need to recognize that we are losing our most powerful policy instrument. The effects of these other aspects of our policies are uncertain, and it will require some trial and error to figure out where we are going. With respect to communications, I do think it would be useful to tell people the conditions under which we expect to keep rates low and the conditions under which we would be prepared to raise interest rates. I think we can tell them if we think it is going to be soon or if it is going to take some time. But I agree with your point at the beginning, Mr. Chairman--and President Plosser and others said this--we should emphasize the conditions rather than the time period. We shouldn't commit to a time path. I think something like this should help long-term nominal rates better reflect our expectations for the path of policy and could be especially important if markets come to anticipate a firming before we actually anticipate firming. It could come into play, particularly in the context of some massive fiscal stimulus, which seems to be coming. I don't think we want the effects of that fiscal stimulus diminished or crowded out by increases in long-term rates that are based on a false assumption about the effect of the fiscal stimulus on monetary policy. I think being clear about where we want inflation to be over the long run will probably help anchor inflation expectations a bit better--keep them from drifting down when inflation itself is very low and keep real interest rates from rising--and thereby reduce the odds of persistent deflation taking hold. We will have an important opportunity to take a step in that direction if we agree to our longer-term forecasts in January. As President Yellen noted, the Subcommittee on Communications is recommending that. I think voting on an inflation target would be a substantially bigger step. That is, we would have to reach agreement on that. It could be a more powerful signal of our intentions, and it might become necessary. I certainly think we ought to discuss it. It has a lot of implications that we need to look at, including where we will be in a couple of years. I think we need to be careful. A number of people--outside commentators, anyhow--have noted that they thought that we kept our eye too much on macro variables in the low inflation period and that gave rise to these asset-price increases. I disagree, but I think it is an open question. I have seen comments from other members of the FOMC wondering whether we should look at more than just the path for consumer prices when we are setting monetary policy. But let's not do something now without thinking about how it is going to play five or ten years down the road. I also agree with your point, Mr. Chairman, about congressional consultation. Having an inflation target won't have any effect if it is repudiated by the Congress. As soon as we make it, it could have a negative effect. I think changes in the size and composition of our portfolio can affect relative asset prices. I guess I think, President Evans, that changes are more likely to be effective at times like these, when markets are illiquid and participants have very, very strong preferences for one sector or another. When private parties seem unwilling to lend to each other, substituting Federal Reserve credit for private credit can be quite effective. Carefully designed programs can reduce the cost of credit and increase the availability of capital to households and businesses. I see where we are as a natural extension of where we have been. Really since August 2007, we have been using our balance sheet to try to stimulate credit markets. At first we sterilized that by selling Treasury securities. Then we sterilized it by the Treasury selling Treasury securities. Then that program ran out, and we thought we could sterilize it by interest on excess reserves, and it didn't work. But I don't think we have crossed a sudden barrier in the last month or two. It is true that the base has begun to rise because we have run out of the other sterilization options. But I do think it is a natural extension of where we have been for a while. That brings me to the monetary base. I find myself more skeptical about the effect of increases in the monetary base per se than what I hear around the room. Such increases I think are supposed to affect asset prices by inducing banks to substitute into higher-yielding assets. Give them a bunch of reserves, and they substitute into higher-yielding assets like loans. But I wonder how effective that is when short-term rates don't decline with the increase in the base because we are pinned at zero--that is, we are in a liquidity trap--and when banks are reluctant to expand portfolios because they are concerned about capital and their leverage ratio. So I don't really understand the channels through which an increase in the monetary base, under these circumstances, is supposed to affect economic activity. We have seen a huge increase in the base over the last couple of months and no effect on the money supply. Now, that is very short term, I agree. Your observation, Mr. Chairman, was that we saw a big increase in the base in Japan. I agree with President Lacker that they weren't as dedicated to that as they might have been, but I just don't see any evidence that the base isn't going to be absorbed in a declining money multiplier rather than an expanding money supply and increased activity. I don't understand the channels. I think the base, as we are setting this out, is determined by the people who use our credit facilities. I think that is very important, and I don't want to upset that. So I would be very, very hesitant to restructure the directive in terms of the quantity of reserves or the monetary base. I would have to understand much better what that means, and I wouldn't want to constrain the use of liquidity facilities with such a restraint. I think the situation in the 1970s and early 1980s was very different. First of all, the October 6, 1979, meeting that went to monetary targeting was a natural evolution of a lot of work that had relied more and more on the money supply as a way of communicating about policy over time. Second, it was about constraining inflation, holding it down. I do agree, Jeff, that ""too much money chasing too few goods"" is something that people kind of understand. I am not sure that they understand the opposite--too little money chasing too many goods, or whatever, as a cause for deflation. I think it would be very, very difficult to communicate what that meant and how that was supposed to work. So it is a very different situation than we had back then. I do think we can help by increasing and directing our asset expansion in particular directions. We have seen evidence, as Bill showed us in the MBS and GSE purchases and the commercial paper facility. Also I favor the consideration of purchases of long-term Treasury bonds. I think that will help to lower longer-term rates in an environment of large liquidity and term premiums. I would consider expanding our purchases of MBS and GSE debt, if it looks as though they might help bring down mortgage rates. I agree with others who have said that they would be very reluctant to specify such operations with a rate target because I don't think we can really control that. So I think that talking about quantities would be much better, as we have done with the MBS. I would also continue to look for other ways to use our discount window to help restart credit markets or substitute for private markets in which the functioning is impaired, and I would be open to a variety of possibilities. I agree that credit allocation is very uncomfortable for the central bank. We are into that. We have been into that for a while. I wish we didn't have to be there. But I don't see any evidence that the private sector is going to start lending anytime soon on its own. If I saw that some of those other markets with which we weren't involved and weren't likely to get involved--like the junk bond market that Bill showed us in that chart--were beginning to open up without our help, that would be fine. But nothing is happening out there in the markets that we are not touching. I don't think that is only because everybody is waiting for us to intervene in those particular markets, because there are a bunch of them that they know we can't or won't intervene in. So we need to remain open to possible further credit market interventions. This raises very difficult governance issues. Our inability to sterilize and the huge increase in our balance sheet raise very difficult questions about how the Board and the Reserve Banks together carry out their shared responsibility for achieving the objectives of the Federal Reserve Act. It is not so much about legalities as it is about how to reach the best decisions and how best to explain those decisions to the world at large. We have always worked in a collaborative and cooperative way, and I think we need to continue to do that. Crisis management strains the normal collaborative and deliberative mode of Federal Reserve operations. Decisions get made on short notice, often over a weekend, but as you said, Mr. Chairman, we can work at improving our collaboration. The FOMC, as a body, will continue to have the major influence on our communications about the outlook, the likely path of rates, and the acceptability of the inflation outcome. The key elements in our communications have always been and will remain under the control of this group, and that is a large part of what we will be doing. I agree that we should, when consistent with fulfilling our obligations to protect financial stability, consult more and earlier on liquidity facilities. I hope that we can emerge from this discussion and subsequent ones with an agreed-upon framework for what we are doing and what motivates it under these unusual circumstances. I think we--the Federal Reserve System, the FOMC, all of us--should consider issuing an explanatory document on these matters that we can all agree to. I wrote this before this meeting. Now that I have heard the meeting, I am not sure it is possible. But I think it might be worth the effort. Thank you, Mr. Chairman. " FinancialCrisisReport--174 As housing prices slowed and even began declining in some parts of the country, high risk prime loans, including hybrid adjustable rate mortgages, Alt A, and Option ARMs, also began incurring delinquencies and defaults. 625 By March 2008, the total delinquency rate for prime/Alt A loans underlying WaMu and Long Beach securitizations was 8.57%, more than twice the industry average. 626 In 2008, WaMu did not issue any new high risk, nonconforming mortgage securitizations due to, in the words of OTS, “continued market illiquidity, deterioration in the financial condition of the market, and the poor performance of WaMu’s outstanding securitizations.” 627 In the first quarter of 2008, WaMu continued to incur losses as the value of its loan portfolio and mortgage backed securities continued to drop. In February 2008, OTS downgraded Washington Mutual for the first time, changing its CAMELS rating from a 2 to a 3, signifying that the bank was in trouble. Unfortunately, OTS did not follow up with a suitable enforcement action. Consistent with its own practice, OTS should have required WaMu to enter into a public Memorandum of Understanding specifying the measures WaMu would take to remedy its problems. Instead, in March, OTS allowed WaMu to issue a nonpublic Board Resolution in which the WaMu Board generally promised to address various problems, but did not identify any specific actions or deadlines. 628 Also in March 2008, at the urging of the FDIC, OTS required Washington Mutual to allow potential buyers of the bank to conduct due diligence of its assets and operations. 629 Several institutions participated, and JPMorgan Chase made an offer to buy the bank which Washington Mutual turned down. By the end of the first quarter of 2008, Washington Mutual had lost another $1 billion. In April 2008, to reassure the market and its depositors, the holding company raised additional capital of $7 billion from the private sector and provided $3 billion of those funds to the bank. But by the end of the second quarter, WaMu lost another $3.2 billion. Its stock price plummeted, and depositors began withdrawing substantial sums from the bank. In June 2008, as a result of the bank’s financial and deposit losses, the FDIC downgraded WaMu to its lowest internal LIDI rating, an E, indicating “serious concern” that the bank would 625 WaMu’s Chief Credit Officer informed the Board of Directors that WaMu was “heavily concentrated” in residential mortgages and high risk products as well as in “highly stressed” geographic markets, which negatively affected WaMu’s portfolio performance. See 2/25/2008 Credit Risk Overview Report to the Board of Directors, prepared by John McMurray, WaMu Chief Credit Officer, JPM_WM02548447, at 28-29. He reported that WaMu’s mortgages were 1366% of its common tangible equity, the highest percentage of any of the top 20 banks. He also informed the Board that the bank’s residential mortgages “performed very poorly” and WaMu had “generally retained higher risk products (e.g., Option ARMS, 2 nd Liens, Subprime, Low Doc).” 626 OTS Fact Sheet 12, “Securitizations,” Dochow_Darrel-00001364_001. 627 Id. 628 3/17/2008 letter from Kerry Killinger to Darrel Dochow with enclosed Board Resolution, OTSWMS08-015 0001216. See also Treasury and FDIC IG Report at 31. 629 Subcommittee interviews of WaMu Chief Financial Officer Tom Casey (2/20/2010); WaMu Controller Melissa Ballenger (2/14/2010); and OTS Western Region Office Director Darrel Dochow (3/3/2010); 4/2010 “Washington Mutual Regulators Timeline,” prepared by the Subcommittee, Hearing Exhibit 4/16-1j. cause a loss to the Deposit Insurance Fund. It also initiated a special insurance examination of CHRG-111hhrg51592--30 Mr. Volokh," Mr. Chairman, members of the committee, thanks very much for having me here. I was asked to provide an objective First Amendment analysis of the free speech issues raised by regulation of, and liability for, the speech of ratings agencies. I am a scholar of the First Amendment. I am not a scholar of commercial law. And I will try to stick to what I think the First Amendment law sets forth, without opining on what I think is sound financial policy here. So my first point is that the ratings issued by rating agencies are, generally speaking, speech of the sort that is presumptively protected by the First Amendment. They are predictive opinions based on factual investigation, and based on some degree of expertise. In that respect, they are quite similar to the work product of investment newsletters, or, for that matter, of the financial pages of well-respected newspapers. Those, too, offer predictive opinions based on factual investigation with some degree of expertise on the part of the author. Now, those, too, are for-profit entities, or at least they try to be for-profit entities. This does not strip them of First Amendment protection. The First Amendment protection has long been understood as covering for-profit entities. In fact, otherwise, newspapers, magazines, movie studios, all of them would be constitutionally unprotected. To be sure, rating agencies are particularly, or at least were particularly respected, and their speech was found particularly valuable, but the fact that speech is especially valuable generally does not diminish the scope of First Amendment protection that is offered it, and the fact that people rely on that speech, generally speaking, does not diminish the scope of First Amendment protection. So, generally speaking, the First Amendment is presumptively in play here. That is not just my view. That is the view of the Federal circuit courts that have considered this issue in the related context of libel lawsuits by the ratees against the rating agencies. The Sixth and the Tenth Circuits have spoken to this very issue, and have said this speech is generally protected by the First Amendment. Now, to be sure, not all such speech ends up being protected by the First Amendment. So, for example, if an agency is actually paid to issue a favorable report, not just issue a report, but issue a favorable report, that would probably make it commercial advertising, which is much less protected under the First Amendment, much as if a newspaper were paid to write a favorable article about a company--which I believe is considered quite unethical in newspapers, though I am told that it is not uncommon in fluff entertainment magazines and the like--that would presumably be commercial advertising. The fact, though, that there is a payment being made not for the positive review, but a payment being made by a company to the subject of the review, does not make the review commercial advertising. Newspapers routinely take advertising from the very same companies whose products they review, and there is some degree of possible pressure to bias the reviews in this respect. If you want to keep getting advertising from Ford, you may want to write positive reviews of Ford, counteracted by the desire to maintain the value of the newspaper's own brand. But generally, while that risk may lead some papers to be very careful about such practices, those payments do not strip speech of full protection. Likewise there are certain situations in which a company may be hired specifically to give personalized advice to an investor, much like an accountant or a lawyer or a psychotherapist or what have you could be hired to give personalized advice to a client. That would presumably fit the speech into the category of professional-client speech, which is much less protected. And that might, in fact, describe what some rating agencies do in certain circumstances. There are some cases in which rating agencies have been found to do just that. But, generally speaking, the fact that they are professionals who offer expert commentary does not make them subject to this kind of restriction. So long as they are speaking to the world at large, and they are not addressing their advice to the personalized circumstances of a particular person whom they are counseling, their speech generally remains fully constitutionally protected. So such speech would likely be protected categorically to the extent it is treated as a matter of opinion, and would likely be protected under the New York Times v. Sullivan actual malice standard, to the extent that it implies specific, verifiable facts. That means that it wouldn't be judged by a negligence standard, but rather by whether the ratings agencies knew the statements were false or likely to be false. Again, there is lower court case law on that very point. So those, I think, are the constraints in direct regulation or litigation against rating agencies. However, say that the government chooses to say, we will give some special status to certain agencies on condition that, for example, they don't take money from the companies that they rate, or that they only take money from subscribers, and if they don't want to be subject to those conditions, they are free to express their opinions but they will not get this special government-provided status. That kind of restriction on agencies that are given this specialized status as a condition of getting that status would probably be constitutionally permissible. Thank you. [The prepared statement of Professor Volokh can be found on page 123 of the appendix.] " FOMC20080805meeting--104 102,MR. EVANS.," Thank you, Mr. Chairman. Overall there has been little change in the sentiment of my business contacts since our last meeting. Most are still reporting sluggish domestic demand with little evidence of any improvement over the near term. On the price front, everyone continued to cite cost pressures. Manufacturers have long lists of materials cost increases, while retailers note large increases in wholesale prices of imported consumer goods. Everyone discusses how they are planning to continue passing these costs along to customers in second-round effects. Undoubtedly weak market conditions will limit their efforts, but I suspect that many will be successful in raising prices significantly. Turning to the financial situation, to start I should note that I did hear some good reports with regard to liquidity in Chicago financial markets. A contact at the Chicago Mercantile Exchange told us that they conducted extensive liquidity reviews for their largest clearing members, with special scrutiny of firms that had substantial volumes of hard-to-value assets on their books. The clearinghouse was very pleased with the results, finding that these firms had good access to liquidity. Overall, however, my financial conversations this round were relatively downbeat. I did hear some interesting details, though, about the dynamics of the restructuring of credit intermediation. With commercial-mortgage-backed securities markets effectively shut down, a highly rated owner-developer of high-end shopping malls described his increasingly difficult attempts to find funding for his regular flow of balloon payments on mortgage properties. He has gone from restrictive loans from life insurance companies to attempting to put together his own structured-debt securitization. They want to issue bonds backed by the revenues generated from a pool of their high-quality properties and sell them to major fixed-income investment funds. This is one example of what economists like Kashyap and Shin estimate will be a reduction of at least $1 trillion in lending to nonfinancial institutions due to mortgage-related losses at U.S. financial institutions. It is also an example of how firms are trying to find workarounds for the functions that intermediaries used to do for them. But such restructuring must be raising the cost of financing in ways that are not obviously amenable to mitigation through liquidity policies. Turning to the national outlook, the information we have received over the past several weeks has contained many crosscurrents, but overall our forecast for output growth is little changed from our June projections. With regard to prices, I am concerned that inflation risks continue to grow. The most recent news on core prices has not been good. Oil prices may be coming off the boil, but they are still scalding. Prices are still down only to where they were in May. My impression from my contact calls is that the ultimate pass-through to final product prices of earlier increases could take a disconcertingly long period of time. Furthermore, I continue to think that the current funds rate in conjunction with our enhanced lending facilities represents a quite accommodative monetary policy stance, even given the disruptions in financial markets. If the policy path remains as accommodative as futures markets expect, then improvement in inflation will most likely require fortuitous favorable developments in inflation expectations and more restraint from resource slack than we might have otherwise expected. This brings me to three considerations that I would like to highlight as we evaluate the riskmanagement positions underlying our views on appropriate policy and our economic projections. The first factor is that, according to many econometric estimates, the 5� to 6 percent unemployment rate envisioned in the projections would provide only very modest restraint on inflation. In addition, costly reallocation could lead to less resource slack, perhaps temporarily driving the NAIRU above 5 percent. You know, when I talk to my staff, they assure me that there are very good reasons, demographically based, to believe a NAIRU under 5 percent. But I tend to think I've read a few too many papers on policy and policy mistakes where that's exactly the issue--when you think the sustainable unemployment rate is lower than it actually is. So that's a risk, I think. The second factor is that many individuals and businesses see the large relative price changes in oil, food, and commodities as precursors to more-persistent inflation. Whether or not their assessments are analytically correct depends on their expectations of our policy response. A substantive response may be necessary to prevent self-fulfilling price increases and keep inflation under control. Words can take us only so far. The third consideration is the potential diminishing returns through our efforts to mitigate distressed financial market conditions. It is my interpretation that our current accommodative monetary policy and suite of lending facilities are set to mitigate severe downside risks and the systemic risks that you mentioned earlier, Mr. Chairman. This is helpful under the assumption that reducing liquidity strains will assist financial markets to return to normal operations and prevent a permanent impairment of our financial infrastructure. But financial conditions seem unlikely to return to our previous perceptions of normal, at least for some time. Thus, I see a risk that extra accommodation intended to grease the financial wheels could be left in place too long and prove counterproductive for price stability. Indeed, the old perception of ""normal"" likely is not the correct benchmark for us to use in looking for whether we are experiencing structural changes in the intermediation process in which new liquidity providers are playing enhanced roles in the lending process and in which risk standards are changing. So when thinking about market functioning, it would be useful to discuss this within a longer-term framework of what we can feasibly expect from market functioning and what central bank liquidity has the ability to usefully and appropriately influence. Thank you, Mr. Chairman. " CHRG-111hhrg58044--403 Mr. Pratt," I think the laws today respond directly. We cannot discriminate. We cannot unintentionally discriminate. I think the way the FCRA works today, employers know they have responsibilities to decide when it is appropriate to use a credit report. I do not think I have seen enough to know precisely when to choose yes or no. " FOMC20080430meeting--93 91,MR. FISHER.," Mr. Chairman, I want to focus my comments today on what I have heard from my CEO contacts. With regard to my District, it continues to do well relative to the rest of the country, but it is not immune to the pathology that is afflicting the overall economy. Although still positive, economic growth and employment creation are slowing, and our manufacturers in the survey we just took are experiencing substantial price pressures. Seventy-one percent of our manufacturers in the survey report higher prices, and 65 percent are expecting input prices to be even higher six months from now. Setting aside the 11th District, I spoke in depth to 31 CEOs nationwide. You have that list, Mr. Chairman, and I would like to speak to what I deduced from triangulating those conversations with what I read in the Bluebook and the Greenbook. Let me note that the focus of my conversations with these CEOs and CFOs was not what they have seen or what they are seeing now but how their behavior is likely to be affected going forward and how they are budgeting going forward. Distilling the inputs to their essence, it's clear that activity is likely to weaken further. Those 21 miles of 89-foot flat cars that haul lumber, Mr. Chairman, are now up to 22.6 miles. Inventories of unsold homes are clearly building, and that is important against the background that March is almost always a good month in the housing or home sales business. The CEO of Centex reports that this is the first down March he has seen, and he has been in the business since 1974. It came down hard--20 percent. Consumer confidence is weak. Job insecurity is spreading. Companies are tightening their head counts. Banks are tightening credit standards, as we have discussed. According to the CEO of MasterCard, year-over-year retail sales to date in April--that is, ex-autos and ex-gas--were 2.2 percent, the lowest he has ever seen. Citibank, Chase, Bank of America, and the other credit card purveyors are experiencing high delinquency rates and a significant slowdown in their revenues from credit cards, and Wal-Mart reports the ""cascading"" use of credit as a form of payment, as their CEO for U.S. operations put it. In short, the consumer-driven corrective credit cycle is prolonging the economic slowdown and vice versa. Consistent with this sustained headwind, we have revised downward the Dallas forecast and continued for longer our projection of economic ""anemia"" (we are not among the four that included the word ""recession"") not only for '08 but also for '09, and we have revised upward, to the upper end, our sense of projected unemployment. Thus, from what I am hearing, from what I am reading, and from what we are getting from our analysis, I acknowledge the thesis of the presence of a negative feedback loop among GDP growth, employment growth, and credit market conditions. I find more worrisome the reports I am receiving on expected price developments and behavior, and I see a feedback loop of another kind at work. Page 30 of the Bluebook notes, as I think President Plosser pointed out and President Evans referred to, that core PCE inflation has averaged more than 2 percent in every year since 2004 and is forecasted, as per David's earlier comments, as doing so again in 2008. What concerns me more is the left-hand panel in chart 1 on page 4 of the Bluebook that indicates that the staff's index of inflation expectations and uncertainty is now at the top of its range over the last decade. This is confirmed by my corporate contacts. Something persistent and pernicious, Mr. Chairman, has been occurring on the inflation front and calling into question the credibility of our continued reliance on core measures. Here is what I am hearing from my corporate contacts. I'm going to just mention a few because it is fairly consistent across the board. From the CEO of the largest retailer in the country, not to be named but located in Arkansas, [laughter] I reported last time that they are budgeting price increases on 10,000 items of a little over 5 percent in 2008. Yet his comment to me was, ""Inflation is our number 1 concern, and it's escalating significantly."" He added, ""All the information we have points to an intermediate- and longer-term supply�demand problem, especially for food and any energy-dependent articles."" By the way, that was verified by the CEO of Frito-Lay, who tells me that they are offsetting their input price escalation of 11 percent in 2008 by raising prices 9 percent effective last Sunday. He added that--and this is interesting in terms of the mindset--""We have to--otherwise we'll disappoint the Street, and in these markets no one can afford at this fragile time to do so."" The price pressures are less for clothing and nonfood items, but they are still there. I would like to use the example of JCPenney. JCPenney sells clothing to one-half of all the families in America, and 60 percent of their sales are apparel. The average price point for an apparel sale at that retailer is $15. The leading source of apparel is China. According to Penney's CEO, increases in China's labor costs, changes in their labor rules, and the cost of fuel and of cotton fibers have led to significantly escalating price pressures. He says that they can eat some of those costs and drive them down through other offsets and tighter controls, but they are planning a 4 percent increase in apparel costs in 2009. Here is his punch line, and it is not funny--this is a first-rate CEO, one of the best in the country: ""We think the customer can take a little more price. After all, what's 40 to 60 cents on $15? It won't even be noticed."" This is the essence of the accommodation of inflationary expectations, and you are beginning to see this mentality set in in several industries. For example, the airlines. We talked about the increase in the price of crude. If you take what is called the crack spread and figure out what has happened in terms of jet fuel, year over year through mid-April jet fuel was up 70 percent. That's an industry average, mitigated somewhat by the hedging of Southwest Airlines, which has been successful. According to the CEO of American Airlines, ""This oil is a tsunami. We will have to get some pricing power, or we'll be left with only one airline, Southwest."" Kimberly-Clark, a paper producer, notices that the weaker dollar and oil are driving realized costs increasingly up from, in their case, $250 million in '07 to an estimated $600 million in '08. They have raised prices, as I have previously mentioned, but the CEO feels that--and this is a winner--""We are having to learn how to run a business in an inflationary environment. We got used to productivity as the driver, but we can't drive productivity any harder than we can. We will need more pricing."" It even affects semiconductor producers. Texas Instruments reports that the weakness of the dollar and the prices of energy, gold, and copper offset by their hedges added 2� percent nonannualized to their costs in the first quarter. Asked what he envisions going forward, the CFO said, ""Well, that just means we can't spend it elsewhere. We have to take it out of our employees' backs or out of cap-ex."" One CEO of a company that is expecting soon to lay off between 12,000 and 15,000 people and is, therefore, carefully surveying the attitudes of their employees because they have a morale problem, is finding out that employees are tapping into their 401(k) plans or not funding them. In their surveys they find the leading complaint is that ""the price of gasoline and food is eating into my living standards. I can't afford them."" Last but not least, just to bring this home, the Eagle Scout who mows my lawn in Dallas sent me a very nice, beautiful letter. It is clear that he and his mother had prepared it on a printer and put a fancy title on it, but the rest of the letter was, ""Dear Mr. Fisher, I have to levy a 7 percent fuel surcharge."" [Laughter] We gave into it--he is a nice boy. In summary, Mr. Chairman, while there are many who have voiced concern with the adverse feedback loop that runs from the economy to tighter credit conditions and back to the economy, I am very troubled by a different adverse feedback loop--namely, the inflation dynamic whereby reductions in fed funds rates lead to a weaker dollar and upward pressures on global commodity prices, which feed through to higher U.S. inflation. That higher U.S. inflation not only has a price impact but also leads to cutbacks by consumers and by employers so as to offset the effects of inflation. I am worried that, if we do not respond to higher inflation, the whole cycle will intensify. When economic growth and activity return to normal, inflation is likely to have notched up considerably, according to our sense. I know my respected colleagues say that we are willing to be equally aggressive in raising rates once the outlook for real activity improves, but the practicability of that notion I find in talking to my interlocutors is met with some skepticism and doubt. With that, Mr. Chairman, I see a tail risk on the downside of growth. I acknowledge the argument of President Yellen and others. I think I'm sympathetic, but I see a fatter tail, perhaps an otter's tail, on inflation. I am hearing this loud and clear from my corporate contacts. I believe that the risk posed by inflation is more significant than the extension of further anemia in the economy, especially now that we have put in place innovative liquidity bridging mechanisms, which we are amplifying upon today. Mr. Chairman, the other day Governor Kohn reminded me that reasonable people can disagree, and he quipped that he hoped that we could agree on the following--that we are at least reasonable people. [Laughter] I'm doing my very best, I hope, to provide reasonable alternative perspectives, and I hope you will judge me on that basis. Thank you, Mr. Chairman. " CHRG-110hhrg44901--17 Mr. Bernanke," Well, our principal policy toward the dollar is to have a strong economy. The Federal Reserve is mandated to provide strong growth and price stability. My belief is that if we work effectively to achieve that objective, the dollar strength in the medium term will reflect that healthy underlying economy. Market intervention is a policy that has been undertaken a few times. I think it is something that should be done only rarely, but there may be conditions where markets are disorderly where some temporary action might be justified. I think the dollar in the long term depends really on the fundamentals, and it is up to us to get the fundamentals right. " FinancialCrisisReport--143 F. Destructive Compensation Practices Washington Mutual and Long Beach’s compensation practices contributed to and deepened its high risk lending practices. Loan officers and processors were paid primarily on volume, not primarily on the quality of their loans, and were paid more for issuing higher risk loans. Loan officers and mortgage brokers were also paid more when they got borrowers to pay higher interest rates, even if the borrower qualified for a lower rate – a practice that enriched WaMu in the short term, but made defaults more likely down the road. Troubling compensation practices went right to the top. In 2008, when he was asked to leave the bank that failed under his management, CEO Kerry Killinger received a severance payment of $15 million. 532 (1) Sales Culture WaMu’s compensation policies were rooted in the bank culture that put loan sales ahead of loan quality. As early as 2004, OTS expressed concern about WaMu’s sales culture: “The overt causes for past underwriting concerns were many, but included: (1) A sales culture focused heavily on market share via loan production, (2) extremely high lending volumes.” 533 In early 2005, WaMu’s Chief Credit Officer complained to Mr. Rotella that: “[a]ny attempts to enforce [a] more disciplined underwriting approach were continuously thwarted by an aggressive, and often times abusive group of Sales employees within the organization.” 534 The aggressiveness of the sales team toward underwriters was, in his words, “infectious and dangerous.” 535 In late 2006, as home mortgage delinquency rates began to accelerate and threaten the viability of WaMu’s High Risk Lending Strategy, Home Loans President David Schneider presided over a “town hall” meeting to rally thousands of Seattle based employees of the WaMu Home Loans Group. 536 At the meeting, Mr. Schneider made a presentation, not just to WaMu’s sales force, but also to the thousands of risk management, finance, and technology staff in 532 See “Washington Mutual CEO Kerry Killinger: $100 Million in Compensation, 2003-2008,” chart prepared by the Subcommittee, Hearing Exhibit 4/13-1h. 533 5/12/2004 OTS Safety & Soundness Examination Memo 5, “SFR Loan Origination Quality,” at 1, Hearing Exhibit 4/16-17. 534 Undated draft WaMu memorandum, “Historical Perspective HL – Underwriting: Providing a Context for Current Conditions, and Future Opportunities,” JPM_WM00783315 (a legal pleading states this draft memorandum was prepared for Mr. Rotella by WaMu’s Chief Credit Officer in or about February or March 2005; FDIC v. Killinger , Case No. 2:2011cv00459 (W.D. Wash.), Complaint (March 16, 2011), at ¶ 35). 535 Undated draft WaMu memorandum, “Historical Perspective HL – Underwriting: Providing a Context for Current Conditions, and Future Opportunities,” JPM_WM00783315, at JPM_WM00783322. 536 Mr. Schneider told the Subcommittee that this meeting was held in early 2007, but Ms. Feltgen’s end of 2006 email to her staff quotes Mr. Schneider’s language from this presentation. 1/3/2007 email from Ron Cathcart to Cheryl Feltgen, Hearing Exhibit 4/13-73. attendance. 537 The title and theme of his presentation was: “Be Bold.” 538 One slide demonstrates the importance and pervasiveness of the sales culture at WaMu: 539 CHRG-111shrg54675--9 Mr. Michael," Chairman Johnson, Ranking Member Crapo, and Members of the Subcommittee, thank you very much for the opportunity to testify at today's hearing on behalf of the Credit Union National Association. My name is Frank Michael, and I am President and CEO of Allied Credit Union in Stockton, California. Allied is a small institution with $20 million in assets and approximately 2,600 member owners. Credit unions--rural, urban, large, and small--did not contribute to the subprime meltdown or the subsequent credit market crisis. Credit unions are careful lenders. As not-for-profit cooperatives, our objective is to maximize member service. Incentives at credit unions are aligned in a way that ensures little or no harm is done to our member owners. Rural credit unions are unique in many respects. There are nearly 1,500 U.S. credit unions with a total of $60 billion in assets headquartered in rural areas. Rural credit unions tend to be small--even by credit union standards. Over half of the rural credit unions are staffed by five or fewer full-time equivalent employees. Even in good times, rural credit unions tend to face challenges in a way that larger institutions do not. Competitive pressures from large multistate banks and nontraditional financial services providers, greater regulatory burdens, growing member sophistication, and loss of sponsors loom large for most of the Nation's small credit unions. A bad economy can make things even worse. Small credit unions come under tremendous pressure as they attempt to advise, consult with, and lend to their members. In addition, all credit unions have suffered as a result of the effects of the financial crisis of corporate credit unions. Despite these substantial hurdles, rural credit unions are posting comparatively strong results, and they continue to lend. Loans grew by 7 percent in the 12 months ending in March compared to a 3-percent decline at all banks. There are several concerns raised by small credit unions, and rural credit unions in particular, that deserve mention. The credit union movement has seen small institutions merge into larger credit unions at an alarming pace. And by far, the largest contributor to this consolidation is the smothering effect of the current regulatory environment. Small credit union leaders believe that the regulatory scrutiny they face is inconsistent with both their exemplary behavior and their nearly imperceptible financial exposure they represent. A large community of credit unions, free of unnecessary regulatory burden, would benefit the public at large and especially our rural communities. As the Subcommittee considers regulatory restructuring proposals, we strongly urge you to continue to keep these concerns in the forefront of your decision making. Moreover, we implore you to look for opportunities to provide exemptions from the most costly and time-consuming initiatives to cooperatives and other small institutions. As noted above, credit unions have generally continued to lend while many other lenders have pulled back. This is certainly true in the business lending arena. Currently, 26 percent of all rural credit unions offer member business loans to their members. These loans represent over 9 percent of the total loans in rural credit union portfolios. In contrast, member business loans account for less than 6 percent of all total loans in the movement as a whole. Total member business loans at rural credit unions grew by over 20 percent in the year ending March 2009, with agricultural loans increasing by over 12 percent. Agricultural loans at rural credit unions now account for over one-third of the total member business loans. This is strong evidence that rural credit unions remain ``in the game'' during these trying times. But more could be done. And more should be done. A chorus of small business owners complains that they cannot get access to credit. Federal Reserve surveys show that the Nation's large banks tightened underwriting standards for the better part of the past year, and SBA research shows that large bank consolidation is making it more difficult for small businesses to obtain loans. The chief obstacle for credit union business lending is the statutory limits imposed by Congress in 1998 under which credit unions are restricted from member business lending in excess of 12.25 percent of their total assets. This arbitrary cap has no basis in either actual credit union business lending or safety and soundness considerations. Indeed, a report by the U.S. Treasury Department found that delinquencies and charge-offs for credit union business loans were much lower than those of banks. While we support strong regulatory oversight of how credit unions make member business loans, there is no safety and soundness rationale for the current law which restricts the amount of credit union business lending. There is, however, a significant economic reason to permit credit unions to lend without statutory restriction, as they were able to do prior to 1998. A growing list of small business and public policy groups agree that now is the time to eliminate the statutory credit union business lending cap. We urge Congress to eliminate the cap and provide NCUA with the authority to permit a credit union to engage in business lending above 20 percent of assets if safety and soundness considerations are met. If the cap were removed, credit unions could safely and soundly provide as much as $10 billion in new loans for small businesses within the first year. This is an economic stimulus that would truly help small business and not cost the taxpayers a dime. In conclusion, Chairman Johnson and Ranking Member Crapo, and all the Members of the Subcommittee, we appreciate your review of these issues today. " CHRG-111shrg50564--186 Mr. Dodaro," Well, I clearly think--and I will ask Ms. Williams to comment on this because she has been doing a lot of our work on these instruments. But, first, clearly the goal has to be set for them to do that. And I think if the Congress sets a statutory--as part of the regulatory goal, an expectation that occur, that is there, I think they need to be given then the authorities to be able to hire the necessary people and compensate them appropriately for doing that. And I do think they would have the capability to be able to do it. There is no doubt in my mind that you have some very talented people in the regulatory system right now that, given the proper goals and expectations, can, you know, develop in that area. It will not be easy because of the ingenuity of many of the market participants, but I think it is achievable. Orice, do you have anything? Ms. Williams. The only thing that I would add is that this is an area that the regulators are always going to be at a disadvantage in dealing with because the markets are always looking to come up with new and innovative products. But I think one of the things that would really help--and we tried to speak to this with our principal, focused on having, you know, a flexible, nimble process for regulators to be able to adjust, is to get beyond the type of product and the label that is attached to a particular product and really be able to focus on the risk that that product may pose to the system and making that the focus and the driver for whether or not products need to be brought under a regulatory umbrella. Senator Warner. So actually making a risk assessment of the product, and then if the assessment was the product was too risky, then perhaps saying some universes of consumers might not be eligible to---- Ms. Williams. Or that it needs to be, you know, regulated or looked at from a regulatory perspective and not just focus specifically on it meets this statutory definition so, therefore, it falls out of a regulatory jurisdiction versus it poses this particular risk to the system, therefore, it needs to be subject to some level of regulation and oversight. Senator Warner. We had that situation last week in the Madoff hearing where we had both SEC and FINRA here, and, you know, asked very much suddenly, you know, on broker-dealers, if somebody says they were an investment adviser and FINRA is looking, they are going to suddenly stop and not turn over that information. These regulatory lines clearly in that case might have precluded exposing a real financial scam. Ms. Williams. Exactly. And one example, we have worked looking at credit default swaps, and that is another example of a product that meets a definition and, therefore, there is---- Senator Warner. No examination beyond meeting the definition. Ms. Williams. Exactly. Senator Warner. Amen. Thank you very much. Ms. Williams. You are welcome. Senator Akaka. [Presiding.] Thank you very much, Senator Warner. Mr. Dodaro, it is good to see you again, and our panel. I am so glad that we have a new team that is addressing the problems that we are facing immediately. And I think you know the history of the so-called Financial Literacy and Education Commission. That is chaired by the Secretary of Treasury, and it has a mission that has really not been carried out. And I think that is an answer to some of the problems that have been mentioned here. Previously, I heard about protecting the consumers. Well before the current economic crisis that we are facing at this time, financial regulatory systems were failing--failing to adequately protect working families from predatory practices and exploitation. And this Commission was really put in place to try to prepare strategies that would deal with the problems that people in the country would have. I would tell you that one of the huge problems that this country has is that this country is financially illiterate. And so these financial literacy programs fill that void, and we need to really, I feel, try to bring that back to life and to help the causes here. Families have been pushed into mortgage products with associated risks and costs that they could not afford. And instead of utilizing affordable, low-cost financial services found at regulated banks and credit unions, too many working families have been exploited by the high cost of fringe financial service providers such as payday lenders and check cashers. I would tell you--and I am sure it is not only in Hawaii--that you find offices like these outside of our bases, and so our military personnel really suffer on this. So my question to you, Mr. Dodaro, is: How do we create a regulatory structure that better protects working families against predatory practices? " CHRG-110hhrg44900--131 Mr. Hensarling," Mr. Chairman, in another speech, you were quoted as saying, ``Under more robust conditions we might have come to a different decision about Bear Stearns.'' Again, you haven't been at the Fed for 70 years, but this is the most extraordinary remedy. Looking in the rear view mirror, were there other circumstances that you believe that the Fed should have opened the discount window to non-depository institutions in the past, and by what criteria, what extraordinary criteria will be used under your current authority to do it in the future? " FOMC20080318meeting--114 112,VICE CHAIRMAN GEITHNER.," So maybe to echo the dialogue that you had with Governor Mishkin, if we were to be successful through taking out some of the liquidity risk of markets more generally and we got those spreads maybe back down to--I don't know--50, in a crude proxy sense, that would be good and powerful but we would still be left with exceptionally tight financial conditions relative to the given target fed funds rate. Is that fair? I mangled that. " FOMC20070321meeting--111 109,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. Our view of the outlook has changed since our last meeting, but more in the balance of risks and the sources of uncertainty than in our actual forecast for growth. But just to go through the changes quickly, we’ve reduced our forecast for growth in ’07 a bit, to something less than 3 percent, and we see more downside risks to that forecast. We’ve moved up the expected path of core PCE inflation just a bit in light of recent numbers, but we have maintained essentially the same view as before—that inflation will moderate to around 2 percent by the end of this year and a bit below that in ’08. We see the risk to this forecast still to the upside. We face greater uncertainty about the near-term outlook than we have over the past few meetings. Looking to the medium term, although we haven’t yet reduced our estimate of potential growth, we’re a bit more concerned than we’ve been about the strength of underlying structural productivity growth going forward. We have also changed our view of the appropriate path of policy a bit, introducing a gentle move down now in the fed funds rate beginning around the middle of the year. So this puts us a bit below the assumed path in the Greenbook, but we assume a slower, smaller reduction in the nominal fed funds rate than the market does today. Our forecast is quite close to that of the staff’s in the Greenbook, and the basic story is similar. Our differences are the same as they have been for some time—we have slightly more growth and slightly lower inflation. That reflects things we talked about before, different views about information dynamics and about potential growth. Our view of the output gap and its evolution, however, is similar. I have just a few points on some issues. On the growth front, the recent numbers suggest both a deeper adjustment in housing and a broader weakness in the economy than we anticipated, notably in capital goods orders. The effect of these developments on our forecast is not that large, however. Their significance is more in the risk to the outlook and the uncertainty, the puzzle that the investment weakness presents for the medium term. On housing and consumption, the probability of the dark scenario is still small, but it is higher than it has been and deserves some attention. The dark scenario is the risk that the reduction in credit to the household sector amplifies the decline in housing demand, which leads to a greater adjustment in prices, with a risk of a more- pronounced, prolonged decline in growth and spending. Monetary policy should not be directed at trying to put a floor on housing demand or on prices, only at limiting the risk that the weakness accumulates substantially or spreads to overall demand. Regarding capital spending, we just don’t have a good explanation for why—with margins that are still pretty good, reasonable earnings growth, solid growth in aggregate demand here and globally, relatively low interest rates, and reasonable levels of business confidence—spending has continued to come in well below our expectations. This series of disappointments, of course, has been going on for some time; it’s not just about the latest numbers for durable goods orders. Perhaps this situation will prove transitory, but it justifies a bit more caution to the outlook. Of these two risks—in housing and in investment—I’d say the latter matters more and is potentially more consequential. But both of these effects are offset, in our basic view, by the expected strength in personal income growth going forward, by what are still fairly favorable overall financial conditions, and by fairly robust external demand. Regarding productivity, productivity growth per quarter at an annualized rate has, over the past ten quarters, come in significantly below 2 percent, kind of close to the estimates of the trend rate for the period between ’73 and ’95. Some of the analysts who spend a lot of time thinking about this are starting to lose conviction that trend growth is still in the neighborhood of 2½ percent for the nonfarm business sector. We’re still viewing the recent weakness as transitory or cyclical, but the risk that trend growth is below our estimate is, I think, increasing. On inflation, despite the higher recent numbers, not much has really changed in our view. We still expect core PCE to move to below 2 percent over the forecast period, and we still see the risk as not getting quite that moderation. The sources of the recent negative surprises in the core data, which seem concentrated in medical services, probably don’t say much about monetary policy or broader inflation dynamics, and inflation expectations remain stable at reasonable levels. So our view of the growth outlook has changed a bit, but our view of the inflation outlook hasn’t changed much based on these numbers. On the markets, as many people have said and as Bill discussed at the beginning, I don’t see much that’s been troubling thus far. Although correlations across asset markets have risen, overall liquidity seems fine. There’s been very limited contagion from mortgages into other credit markets. Debt issuance seems to be continuing. People are able to raise money to finance corporate restructuring investment. There is very little concern, I think, about substantial losses, on the basis of what’s happened to date, in the core of the financial system and very limited evidence of stress among the various funds. But it’s still early in some ways, and the fundamental outlook for growth is a bit weaker and more uncertain. Risk premiums, credit spreads, and volatility still look potentially vulnerable to a more substantial reversal. The weakness in the subprime market will take some time to work through the full range of securities issued against pools of collateral that include mortgages. The complexity in valuing structured mortgage products, the difficulty in designing hedges that actually work against exposure to that risk, and uncertainty about the shape of the adverse tail and that part of the credit spectrum are all conditions that apply to a range of other structured credit markets and credit products. In the debate about the implications of this prolonged yield-curve inversion, we have tended to side with those who have found comfort in the contrary signal you see in lower levels of risk premiums and credit spreads. Yet it’s possible that the forces that may have been holding down forward rates are also holding down credit spreads and holding up the value of other assets and, therefore, may be masking weakness in the economy rather than masking strength. On balance, although the outlook still looks fundamentally positive, we see a more complicated and less benign set of risks to the outlook, more downside risks to growth, and some continued concern that we won’t get enough moderation in inflation. To us, this outlook justifies a stance of policy with a path for the fed funds rate somewhat above what is now priced into the markets. This doesn’t mean, in our view, that we need to signal that nominal rates going forward are more likely to rise than to fall from current levels; it means only that we should convey the sense that our view of the most likely evolution of policy still implies a higher path than is now priced into the markets. We can afford to be patient before adjusting policy, as Sandy said, but we need to have as much flexibility as possible going forward. This suggests that we acknowledge that the overall balance of risks has shifted a bit toward neutral, toward a flat stance of policy, but not all the way there. A delicate task for us is to do this without inducing a reaction in the market that pulls forward significantly more easing than has already occurred." CHRG-111hhrg56847--23 Mr. Ryan," Thank you, Chairman. It is good to have you back. Sovereign CDS spreads have driven back upwards in recent weeks. Some countries' bond yields, I think Spain and Italy, reached fresh highs this week. And the European funding markets are still pretty tight. In your opinion, is the ECB doing everything it needs to do from a policy action standpoint to stem this crisis? How do you gauge the risk of contagion with this crisis spilling over? And what is the endgame if conditions get worse? " CHRG-111hhrg53245--244 Mr. Donnelly," Thank you, Mr. Chairman. We have been talking about too big to fail, and there is another area and that is too big of an effect on the entire market. And, Mr. Zandi, I want to ask you, and I read your statement where it talked about emerging market investors did little or no research of their own and that the credit--this could not have occurred without someone providing the credit. But did not the triple A ratings given by Moody, is not that how the credit flowed was if you give me triple A, the credit will come from that? And so we had a large investor who talked to us and said if the credit rating agencies had not done that, this never would have started in the first place? " FOMC20050322meeting--224 222,MR. FERGUSON.," Thank you, Mr. Chairman. I support your recommendation of 25 basis points and I support alternative B. On the broad issues, I think we have to continue to attempt to have in our statement some forward-looking language, as painful as it may be. I did not support the move toward having the minutes come out earlier as a tradeoff. I know that was in some people’s minds, but I think in the statement itself some forward-looking language about the economy is useful. It is sort of modern-day central banking practice, and anything other than that, I think, is a step backward and is likely to have a detrimental impact not only on our credibility but also on the market functioning. On the word “measured,” as I said earlier, I think that’s conditioned upon the expectation of inflation being relatively well contained. And if that condition in fact turns out not to be true, then we could move more quickly, and I don’t believe it would be undercutting our commitment, if that’s what it is, to “measured pace.” To me it would just be a way of interpreting the measured pace. On the process of getting this language out to us earlier, I look forward to seeing how the Secretary manages to do that, and I will attempt to be as constructive and helpful in that process as possible. It does remind me that this year—many of you didn’t follow this sport—there was a snowboarding championship won by a 23-year-old woman who did her world famous patented step called “the crippler.” I expect to see a “crippler” coming to monetary policy as Vincent attempts to get this language out that much earlier. [Laughter]" FOMC20080121confcall--3 1,MR. DUDLEY.," Thank you, Mr. Chairman. Since our videoconference on January 9, the market functioning in terms of the bank term funding markets has generally continued to improve, with the one-month and three-month LIBOR relative to the overnight index swap rates coming back very sharply. They are now as narrow as they've been since the market turmoil began. But elsewhere in terms of market functioning, we started to see a step backward last week--especially late in the week--when we viewed the asset-backed commercial paper market beginning to deteriorate again, and there was some flight to quality into the Treasury bill market late last week. More important, the macro outlook and broader financial market conditions have continued to deteriorate quite sharply. The S&P 500 index, for example, fell 5.4 percent last week; it is down almost 10 percent so far this year. Today it fell another 60 points, or 4.5 percent, so that means that the cumulative decline in the S&P 500, if it opens near where the futures markets closed today, will be nearly 15 percent since the start of the year. Global stock markets were also down very sharply today--Monday. Depending on where you look, the range of decline was anywhere from 3 percent to 7� percent, pretty much across the board. Corporate credit spreads and credit default spreads have continued to widen, and bank mark-tomarket losses and loan-loss provisions keep increasing. The Merrill Lynch and Citigroup earnings announcements last week generally suggested a widening in terms of the scope of losses, not just in subprime but also in terms of credit card receivables and other loans. A newish wrinkle here in terms of bank markdowns reflects the deterioration of some of the monoline guarantors. Merrill Lynch, for example, announced a multibillion dollar charge for its exposure to ACA, which is the most impaired of the monoline guarantors. The other monoline guarantors are in better shape, but they've either been downgraded, such as the case of Ambac by Fitch on Friday afternoon, or are under review for being downgraded by a number of different credit-rating agencies. The problem with the monoline guarantors is that raising capital has become much more difficult. Ten days ago, for example, MBIA issued 14 percent surplus notes, which are now trading at about 70 cents on the dollar. It's not clear how much additional capital is needed to keep the AAA rating. The goal posts keep moving. S&P, for example, raised its loss estimates on subprime mortgages about a week and a half ago, and this has implications for the monoline insurers in terms of their capital adequacy. So the bottom line is that, unless the monoline insurers raise significant additional capital soon, further rating downgrades seem very, very likely. This has three potential consequences that are noteworthy. First, in the money market space, a number of money market products are wrapped by the monoline guarantors, including variable-rate demand notes, auction-rate securities, and tender option bonds. Some of these securities have liquidity support, so if the securities can't be rolled over, they'll go to the banks, and this will increase the pressure on bank balance sheets. For those without liquidity support, either they will be converted to longer-dated securities, which the investors will be surprised to find out they are holding, or the dealers will have to take them back on their books to prevent the auctions from failing. A second consequence from monoline guarantor downgrades would be to the municipal bond funds. The loss of AAA insurance raises the question of what the retail bond investors do. Do they start pulling out their money and run? So far things are pretty calm on that front. For example, last week the net asset values of some of the major muni bond insurance funds actually increased a bit for the week. So there are no signs of a run there yet, but we haven't really explored this fully, given the fact that only one major monoline guarantor has been downgraded and that happened late, late last week. Third, financial institutions have to mark down the value of the guarantors' insurance as their financial conditions worsen. In contrast, the monolines don't have to mark to market. Downgrading the monolines frontloads the hit to capital and potentially aggravates the magnitude of the hit to capital because market valuations can overshoot. So it is not trivial to transfer this risk from the monolines to the financial institutions given the distinction that the monolines do not have to mark to market but financial institutions that use their insurance do. At this point, monetary policy expectations have priced in a lot of easing over the near term. As of Friday's close, there were about 67 basis points priced in through the January meeting at the end of the month and about 110 basis points priced in through the March meeting (if you look at the April federal funds futures contract). There is likely more than that now given the decline in the equity futures market that we saw today. So the markets are expecting quite a bit from the Fed. I'll be happy to take any questions, of course. " CHRG-110shrg50420--402 Mr. Wagoner," The analysis, as we have reported in other places, showed significant cost savings, some of those--significant cost savings, and some of those were--a large portion initially were exactly the point you raised, Senator Bennett, the sort of squishing together of two headquarters. There was some significant job loss, but beyond that, it looked like there was material savings, platform savings as we combined product platforms together. And then over time, some possibilities of actually incremental sales. For example, Chrysler hasn't historically had a big overseas distribution network. General Motors does, so that would open up prospects. But as you correctly said, as it became clear that such an opportunity would not generate incremental funding from the market--initially, we had been told it would, but as the market conditions deteriorated, it wouldn't--then we had to move our focus to the near-term cash issues that we are facing. Senator Bennett. Mr. Nardelli? " CHRG-111hhrg48873--92 Secretary Geithner," That is a very important question. Thanks for asking it. Within the first weeks of taking office, we put in place a set of clear commitments to put in the public domain the precise terms of all the financial contracts that my predecessor entered into and that we would enter in the future that would provide taxpayer assistance to financial institutions under the Emergency Economic Stabilization Act. Because of that commitment, the American people will be able to see, as I said, the precise terms for the first time of those commitments. In addition, we are going to require extensive reporting by any recipient of TARP assistance to go into how they are going to use those resources, what it is going to do to their lending capacity, and what is actually happening to lending. We have proposed very strong conditions on compensation, on dividends, and a range of other things. But I completely agree that the American people deserve to see much higher standards for transparency and accountability over the use of these resources, and they are understandably skeptical that they are going to see enough benefit from these resources, in part because of the decisions you have seen made across the financial sector in the wake of Congress passing that exceptional authority back in September. " CHRG-110shrg50417--22 Mr. Zubrow," Thank you very much, Mr. Chairman. Chairman Dodd and Members of the Committee, thank you for including us in today's hearing on the Capital Purchase Program. I am pleased to represent JPMorgan Chase before this Committee. You have with you my detailed written testimony. Given the size of this panel, allow me to summarize a few key points. At JPMorgan Chase, we believe that the Government's investment in our firm comes with a responsibility to honor the goals of the Capital Purchase Program. To that end, we are using the CPP funds to expand the flow of credit into the U.S. economy and to modify the terms of hundreds of thousands of residential mortgages. At the same time, we continue to maintain prudent business practices and underwriting standards that have helped JPMorgan Chase to create and maintain a fortress balanced sheet. What does this mean in practice? Let me begin with our loan modification efforts, which we believe will help to strengthen the U.S. real estate markets and to keep people in their homes. Last week, we announced the significantly expanded loan modification program that we expect will help roughly 400,000 additional families to stay in their homes. Since early 2007, Chase has helped about 250 families avoid foreclosure, primarily by modifying their loans or their loan payments. Our new initiative is reaching out to additional customers of Chase, but also to Washington Mutual and the EMC unit of Bear Stearns, which are now part of the bank. As part of these efforts, we are opening 24 regional counseling centers to provide borrowers with face-to-face help in high delinquency areas. We are hiring over 300 new loan counselors, bringing our total to more than 2,500, so that homeowners can work with the same counselor from the start to the finish of the process. Proactively, we are reaching out to borrowers to offer pre-qualified modifications, such as interest rate reductions and principal forbearance. We seek to expand the range of financing alternatives which are available to our customers and to provide an independent review of each loan before moving it into the foreclosure process. Until all of these changes are fully implemented--we hope within the next 90 days--we have stopped any new foreclosure proceedings on our owner-occupied properties. The Capital Purchase Program's goal of providing capital to the U.S. economy is absolutely consistent with our own core business of supporting our customers through lending operations. Despite the challenges economic conditions, we continue to provide credit to our customers, whether they are consumers, small businesses, large corporations, not-for-profit organizations, or municipalities. Throughout the past year, during some of the most turbulent and difficult conditions many of us have ever witnessed, we have prided ourselves on being there for our clients, whether by making markets, committing capital to facilitate client business, investing in infrastructure and other projects, or making loans to creditworthy borrowers. In short, we have been open for business and we continue to be open for business. The CPP enhances our ability to lend to consumers and businesses large and small, and we are committed to honoring the goals of this program. The Committee has also asked us to address executive compensation practices, and I am pleased to do so. JPMorgan is in business for the long term, and our compensation philosophy reflects that. Simply stated, we believe that compensation should be based on the long-term performance of our firm and the individual's contribution to his or her business, and to provide important and appropriate safeguards for safe and sound behavior. We require our senior executives to retain at least 75 percent of all their equity awards that are granted to them so that their interests are aligned with the long-term interests of our shareholders. We offer no golden parachutes or special severance packages. Our top executives are subject to the exact same severance provisions as all of our employees. Even prior to the CPP, our firm had in place a bonus recoupment policy. We have obviously amended that to ensure full compliance with the terms of the CPP. We are not yet in a position to provide specific information about compensation for this year, given that the year is not complete. However, given the type of year we are experiencing and even though we have produced profitable results in each quarter to date, I have little doubt that employees and executives will make substantially less than they did last year. Let me also state very clearly that the CPP money will have no impact on the compensations that are taken for JPMorgan Chase employees or executives. The Government's investment in our firm came along with a special responsibility, as you have noted, Mr. Chairman, to America's taxpayers. We fully intend to honor that responsibility by promoting the goals of the CPP while also acting prudently and sensibly and in the interests of all of our shareholders to maintain a healthy and vibrant company. Many believe that irresponsible lending was one of the causes of the current distress in the financial markets. No one wants a repeat of those mistakes. Every day we seek to make capital available in a responsible, safe, and sustainable way to help get the economy back on track. John Pierpont Morgan once said that he wanted to do first-class business in a first-class way. That continues to be a guiding principle for us. It remains our goal and our commitment to our customers, to our shareholders, our employees, and to the taxpayers of this Nation. Thank you very much. " CHRG-111hhrg53021Oth--43 Secretary Geithner," There are a lot of compelling reasons made by people in this room, and many others over a long period of time, for merging both those agencies. In our judgment it is a necessary condition and the most important and, in some ways the hardest, thing to do is to bring the underlying statutes and laws into conformity and convergence. We think that is the most important thing to do, in part because, as your colleague Chairman Frank said, the critical test of whether we do enough to improve the system is going to be what we do to the basic constraints and incentives, the substance of regulation. So what we proposed in the white paper to do is to begin with that task, which we think is going to be enormously difficult and complicated. And that would provide a better basis for the Congress to consider institutional reforms in the future. " CHRG-111hhrg53021--43 Secretary Geithner," There are a lot of compelling reasons made by people in this room, and many others over a long period of time, for merging both those agencies. In our judgment it is a necessary condition and the most important and, in some ways the hardest, thing to do is to bring the underlying statutes and laws into conformity and convergence. We think that is the most important thing to do, in part because, as your colleague Chairman Frank said, the critical test of whether we do enough to improve the system is going to be what we do to the basic constraints and incentives, the substance of regulation. So what we proposed in the white paper to do is to begin with that task, which we think is going to be enormously difficult and complicated. And that would provide a better basis for the Congress to consider institutional reforms in the future. " CHRG-111shrg57319--72 Mr. Vanasek," I had originally agreed with Mr. Killinger when I was employed that I would work 6 years with Washington Mutual. I was 62 years old. I have a heart condition and four cardiac stents. I thought it time for the sake of my health to leave. Senator Coburn. There is no question in what Senator Levin had laid out that there, in several of the offices of WaMu, especially in Downey and Montebello, that there was fraudulent activity going on, correct? " CHRG-110shrg50420--48 Mr. Dodaro," I would suggest one board, Senator, to ensure consistency. You know, from reading the plans, you obviously have three very different situations that are being presented here, but there needs to be consistency and equity in treatment. One board, Senator. Senator Reed. And with respect to the formulation that you are talking about and one that seems to have been used both with the airlines and with Chrysler back in the 1970s is that the funding, the actual funding was contingent upon the board determining that these conditions had all been met. Is that correct? " CHRG-111shrg57709--21 Mr. Volcker," Well, it is an area you have got to work on and establish policies and procedures. I point out that accountants already face this problem in developing accounting standards as to which transactions of a bank are hedging and which are not hedging in accounting reporting. Take the case of AIG. They were heavily into credit default swaps. A credit default swap is presumably a hedging instrument. But I don't think anybody would look at what AIG was doing and say, oh, this is a hedging operation. It is not a trading operation. It was obviously a trading operation. It had nothing to do with protecting AIG. In fact, it was ruining AIG, it wasn't protecting it. And they were engaging in credit default swaps with people who were perhaps speculating on the other side. " fcic_final_report_full--478 When the housing bubble began to deflate in mid-2007, delinquency rates among NTMs began to increase substantially. Previously, although these mortgages were weak and high risk, their delinquency rates were relatively low. This was a consequence of the bubble itself, which inflated housing prices so that homes could be sold with no loss in cases where borrowers could not meet their mortgage obligations. Alternatively, rising housing prices—coupled with liberal appraisal rules—created a form of free equity in a home, allowing the home to be refinanced easily, perhaps even at a lower interest rate. However, rising housing prices eventually reached the point where even easy credit terms could no longer keep the good times rolling, and at that point the bubble flattened and weak mortgages became exposed for what they were. As Warren Buffett has said, when the tide goes out, you can see who’s swimming naked. The role of the government’s housing policy is crucial at this point. As discussed earlier, if the government had not been directing money into the mortgage markets in order to foster growth in home ownership, NTMs in the bubble would have begun to default relatively soon after they were originated. The continuous inflow of government or government-backed funds, however, kept the bubble growing—not only in size but over time—and this tended to suppress the significant delinquencies and defaults that had brought previous bubbles to an end in only three or four years. That explains why PMBS based on NTMs could become so numerous and so risky without triggering the delinquencies and defaults that caused earlier bubbles to deflate within a shorter period. With losses few and time to continue originations, Countrywide and others were able to securitize subprime PMBS in increasingly large amounts from 2002 ($134 billion) to 2006 ($483 billion) without engendering the substantial increase in delinquencies that would ordinarily have alarmed investors and brought the bubble to a halt. 46 Indeed, the absence of delinquencies had the opposite effect. As investors around the world saw housing prices rise in the U.S. without any significant losses even among subprime and other high-yielding loans, they were encouraged to buy PMBS that—although rated AAA—still offered attractive yields. In other words, as shown in Figure 2, government housing policies—AH goals imposed on the GSEs, the decline in FHA lending standards, HUD’s pressure for reduced underwriting standards among mortgage bankers, and CRA requirements for insured banks— by encouraging the growth of the bubble, increased the worldwide demand for subprime PMBS. Then, in mid-2007, the bubble began to deflate, with catastrophic consequences. 46 Inside Mortgage Finance, The 2009 Mortgage Market Statistical Annual—Volume II , MBS database. 473 2. The Defaults Begin FinancialCrisisReport--254 After calculating the CDO’s default and loss rates and the cushion or subordination needed to protect the pool’s investment grade tranches from loss, the CRA analyst examined the CDO’s capital structure, credit enhancements, cash flow, and legal structure, in the same manner as for an RMBS pool. Evidence gathered by the Subcommittee indicates that it was common for a CRA analyst to speak with the arranger or issuer of an RMBS or CDO to gather additional information and discuss how a proposed financial instrument would work. Among other tasks, the analyst worked with the arranger or issuer to evaluate the cash flows, the number and size of the tranches, the size and nature of the credit enhancements, and the rating each tranche would receive. Documents obtained by the Subcommittee show that CRA analysts and investment bankers often negotiated over how specific deal attributes would affect the credit ratings of particular tranches. Rating Recommendations. After completing analysis of a proposed financial instrument, the CRA analyst developed a rating recommendation for each proposed RMBS or CDO tranche that would be used to issue securities, and presented the recommended ratings internally to a rating committee composed of other analysts and managers within the credit rating agency. The rating committee reviewed and then voted on the analyst’s recommendations. Once the committee approved the ratings, a rating committee memorandum was prepared memorializing the actions taken, and the ratings were provided to the arranger. If the arranger indicated that the issuer accepted the ratings, the credit rating agency made the ratings available publicly. If dissatisfied, the arranger could appeal a ratings decision. 980 The entire rating process typically took several weeks, sometimes longer for novel or complex transactions. RMBS and CDO Groups. Moody’s and S&P had separate groups and analysts responsible for rating RMBS and CDOs. In 2007, Moody’s RMBS ratings were issued by the RMBS Group, which had about 25 analysts, while it had about 50 derivatives analysts in its Derivatives Group, whose responsibilities included rating CDOs. 981 Each group responsible for rating these products was headed by a Team Managing Director who reported to a Group Managing Director. Both the RMBS Group and the Derivatives Group were housed in the Structured Finance Group. The setup was similar at S&P. At S&P, RMBS ratings were issued by the RMBS Group, which had about 90 analysts in 2007, while CDO ratings were issued by 979 Synthetic CDOs, on the other hand, involved a different type of credit analysis. Unlike RMBS and cash CDOs, synthetic CDOs do not contain any cash producing assets, but simply reference them. The revenues paid into synthetic CDOs do not come from mortgages or other assets, but from counterparties betting that the referenced assets will lose value or suffer a specified credit event. 980 7/2008 “Summary Report of Issues Identified in the Commission Staff’s Examination of Select Credit Rating Agencies,” report prepared by the Securities and Exchange Commission, at 9. 981 3/11/2008 compliance letter from Moody’s to SEC, SEC_OCIE_CRA_011212; SEC_OCIE_CRA_011214; and SEC_OCIE_CRA_011217. the Global CDO Group, with about 85 analysts. 982 Each group was headed by a Managing FOMC20050630meeting--195 193,MR. STERN.," Yes. I have a question for Karen about a couple of the charts. One of the things that struck me in looking at the charts for the United Kingdom—whether you look at price­ to-rent ratios or real house prices—is that they obviously have gone through several very sharp swings. If you look at the U.S. historical charts, they’re pretty benign. Dave was just talking about the possible fallout of sharp swings in those measures here, and I was curious whether we could learn anything about the macro consequences or the macro conditions associated with what has happened in the U.K." CHRG-111hhrg52397--49 Chairman Kanjorski," So rather than provide for actionableness as the qualifying factor, do you think that by treaty or international agreement, we could stabilize a world market recognizing standardized conditions? Mr. Don Thompson. I think it would be much more effective and important for American policymakers to make sure that whatever steps we enact here in the United States are broadly consistent with the regulatory regime overseas as well to avoid any regulatory forum shopping of the nature you mentioned before. " CHRG-110shrg50418--5 STATEMENT OF SENATOR TIM JOHNSON Senator Johnson. Mr. Chairman, thank you for calling today's hearing to examine the condition of the domestic auto industry and the effects of interest rate turmoil on job creation and economic growth. As you know, I did not support the $700 billion bailout, in part because I did not believe that the conditions set for bailout monies for Wall Street firms were strong enough. I expect that if help is extended to the auto industry, these companies and their executives will be held to very high standards of accountability and that the taxpayer protection remains a top priority. Going forward, Congress must focus on how to secure the hundreds of thousands of jobs connected to the auto industry and also ensure that this industry makes dramatic improvements to innovate and reflect consumers' changing tastes for fuel-efficient vehicles, including flex-fuel vehicles and alternative-fuel vehicles, cars, and trucks. The U.S. has the ability to lead the world powering vehicles on renewable fuels. What is lacking has been the domestic auto industry's embrace of policies and misallocations of resources, resulting too often in an inferior product. I am keenly interested in learning from today's witnesses as to how additional investment of taxpayer dollars to this interest would not repeat these missteps. Thank you, Chairman Dodd. " fcic_final_report_full--32 Maker told the board that she feared an “enormous economic impact” could re- sult from a confluence of financial events: flat or declining incomes, a housing bub- ble, and fraudulent loans with overstated values.  In an interview with the FCIC, Maker said that Fed officials seemed impervious to what the consumer advocates were saying. The Fed governors politely listened and said little, she recalled. “They had their economic models, and their economic mod- els did not see this coming,” she said. “We kept getting back, ‘This is all anecdotal.’”  Soon nontraditional mortgages were crowding other kinds of products out of the market in many parts of the country. More mortgage borrowers nationwide took out interest-only loans, and the trend was far more pronounced on the West and East Coasts.  Because of their easy credit terms, nontraditional loans enabled borrowers to buy more expensive homes and ratchet up the prices in bidding wars. The loans were also riskier, however, and a pattern of higher foreclosure rates frequently ap- peared soon after. As home prices shot up in much of the country, many observers began to wonder if the country was witnessing a housing bubble. On June , , the Economist magazine’s cover story posited that the day of reckoning was at hand, with the head- line “House Prices: After the Fall.” The illustration depicted a brick plummeting out of the sky. “It is not going to be pretty,” the article declared. “How the current housing boom ends could decide the course of the entire world economy over the next few years.”  That same month, Fed Chairman Greenspan acknowledged the issue, telling the Joint Economic Committee of the U.S. Congress that “the apparent froth in housing markets may have spilled over into the mortgage markets.”  For years, he had warned that Fannie Mae and Freddie Mac, bolstered by investors’ belief that these in- stitutions had the backing of the U.S. government, were growing so large, with so lit- tle oversight, that they were creating systemic risks for the financial system. Still, he reassured legislators that the U.S. economy was on a “reasonably firm footing” and that the financial system would be resilient if the housing market turned sour. “The dramatic increase in the prevalence of interest-only loans, as well as the in- troduction of other relatively exotic forms of adjustable rate mortgages, are develop- ments of particular concern,” he testified in June. To be sure, these financing vehicles have their appropriate uses. But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is be- ginning to add to the pressures in the marketplace. . . . Although we certainly cannot rule out home price declines, espe- cially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications. Nationwide banking and widespread securitization of mortgages makes it less likely that financial intermediation would be impaired than was the case in prior episodes of regional house price corrections.  CHRG-111hhrg58044--46 Chairman Gutierrez," You cannot. It shows up. In other words, Mr. Wilson, if someone does have difficulty paying a hospital bill and it goes to a collection agency, does that show up on the individual's credit report? " FinancialCrisisReport--200 In July 2008, tensions between the FDIC and OTS flared after the FDIC sent a letter to OTS urging it to take additional enforcement action: “As we discussed, we believe that [WaMu’s] financial condition will continue to deteriorate unless prompt and effective supervisory action is taken.” 762 The letter urged OTS to impose a “corrective program” that included requiring the bank to raise $5 billion in additional capital and provide quarterly reports on its financial condition. OTS not only rejected that advice, but also expressed the hope that the FDIC would refrain from future “unexpected letter exchanges.” 763 In a separate email, Scott Polakoff, a senior OTS official called the FDIC letter “inappropriate and disingenuous”: “I have read the attached letter from the FDIC regarding supervision of Wamu and am once again disappointed that the FDIC has confused its role as insurer with the role of the Primary Federal Regulator. Its letter is both inappropriate and disingenuous. I would like to see our response to the FDIC, which I assume will remind it that we, as the PFR, will continue to effectively supervise the entity and will continue to consider the FDIC’s views.” 764 Two weeks later, on July 31, both OTS and the FDIC met with the WaMu Board of Directors to discuss the bank’s problems. At that meeting, the FDIC Dedicated Examiner suggested that the bank look for a “strategic partner” who could buy or invest in the bank. The OTS director, John Reich, later expressed anger at the FDIC for failing to clear that suggestion first with OTS as the bank’s primary regulator. An FDIC examiner wrote to his colleagues: “Major ill will at WAMU meeting yesterday caused by FDIC suggestion in front of WAMU management that they find a strategic partner. [OTS Director] Reich reportedly indicated that was totally inappropriate and that type of conversation should have occurred amongst regulatory agencies before it was openly discussed with management.” 765 The next day, on August 1, 2008, due to WaMu’s increasing financial and deposit losses, the FDIC Chairman, Sheila Bair, suggested that the bank’s condition merited a downgrade in its CAMELS rating to a 4, signaling a troubled bank. 766 The head of OTS sent an email to the head of the FDIC responding that “rating WaMu a 4 would be a big error”: “In my view rating WaMu a 4 would be a big error in judging the facts in this situation. It would appear to be a rating resulting from fear and not a rating based on the condition 760 See 7/21/2008 letter from FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59. 761 Subcommittee interview of Steve Funaro (3/18/2010). 762 7/21/2008 letter from the FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59. 763 7/22/2008 letter from OTS to the FDIC, OTSWMS08-015 0001312, Hearing Exhibit 4/16-60. 764 7/22/2008 email from OTS Deputy Director Scott Polakoff to OTS colleagues, Hearing Exhibit 4/16-59. 765 8/1/2008 email from David Promani to FDIC colleagues, FDIC-EM_00246958, Hearing Exhibit 4/16-64. 766 See 8/1/2008, email from Darrell Dochow to OTS senior officials, Hearing Exhibit 4/16-62. of the institution. WaMu has both the capital and the liquidity to justify a 3 rating. It seems based on email exchanges which have taken place that FDIC supervisory staff in San Francisco is under pressure by the fear in Washington to downgrade this institution. … [P]rior to such action I would request a[n FDIC] Board meeting to consider the proper rating on this institution.” 767 FOMC20080318meeting--65 63,MR. SAPENARO.," Thank you, Mr. Chairman. Eighth District economic conditions have softened, but with considerable variability across industries and local areas. The outlook for District agriculture is very strong in the context of high commodity prices. This prospect is reflected in prices of agricultural land, which in areas within the District have risen at a rate of 20 to 25 percent over the past year in active markets. Production of agricultural equipment for the 2008 crop season is fully booked, and prices of used equipment are at or very close to prices of new equipment. There was major activity in the District energy industry, with significant construction projects of coal-fired generation facilities and rapidly developing exploration and production in the Fayetteville Shale play in Arkansas. Total natural gas production from this source roughly quadrupled during 2007. In a recently published study, it is estimated that the direct impact on Arkansas output from exploration and production will average about $2.5 billion per year for the next five years. For perspective, this is about 2.8 percent of the 2006 Arkansas gross state product. Overall activity in the Evansville, Indiana, metropolitan area is particularly strong. The unemployment rate there has declined year over year from 4.6 to 4.2 percent, and nonfarm employment has grown 1.4 percent from January '07 to January '08. A major investment in the auto parts industry is in the works for this area. Activity in housing markets in the District is soft, with building permits in the four largest metro areas down on average 16.8 percent during 2007. Nevertheless, house prices in the District have held up much better than the national experience. In 21 District metropolitan areas, house prices increased an average of 2.5 percent in 2007, with decreases in house prices reported in only 3 metro areas. However, in contrast to other parts of the nation, these areas did not experience major house-price inflation before 2007. From 2000:Q4 through 2006:Q4, the average annual price inflation in these areas was only 5.3 percent. Foreclosures have increased in 2007 in three of the four largest District metro areas but at much lower rates than nationally, and 2007 foreclosure rates are at or below national averages in three of these four areas. I solicited information on the national economy from a number of sources. Contacts in the air and ground cargo industry report significant cost pressures from higher energy prices. These affect everything from fuel costs to the cost of snow removal. Respondents indicate that these cost increases are significantly but not completely passed through to their prices. International cargo traffic is reported to show strong growth, but with some customers substituting sea for air shipment and choosing less rapid delivery service to reduce cost. Year-over-year traffic out of Asia to both Europe and North America has grown at double-digit rates. One contact indicated that volume appears to have bottomed out in the first half of 2007 and has slowly but steadily improved since. In contrast, a contact in the over-the-road trucking industry reported that there was not much change in the past two months. In his view, the industry has been in recession since December 2006. He sees improvement for his firm going forward not because of increased demand but because of small competitors exiting the industry through bankruptcy. Excluding fuel surcharges, freight prices are flat to down. A contact at a major credit card bank reported that their credit card activity indicates that retail sales, excluding autos, were flat in February and are likely to be flat to down in March. These February data were confirmed by the advance retail sales report last week. He also reported that a smaller percentage of customers are making full payment on their credit cards and that a larger percentage are making only the minimum required payment. He sees delinquencies spreading to credit cards. A contact at a major software producer indicates that revenue growth was robust prior to the first quarter of 2008 and, while remaining strong, has slackened since the beginning of the year. He reports strong retail sales, but that was possibly influenced by reductions in prices. He sees business IT spending in the United States remaining strong and no deterioration in the collection of receivables. Nevertheless, he is less optimistic about the industry outlook now than in January. Finally, a contact in the quick service restaurant industry, or fast food, sees business as stable at the moment, not getting worse but not getting better. He notes that while historically this industry is affected least when the economy slows down, this particular time he sees gasoline prices as a significant factor, with many consumers making fewer trips to purchase low-ticket items. He also views financial markets as closed to all but the largest and most highly rated nonfinancial corporations. In his words, there is no market for deals. The national economy certainly appears headed for a weaker first half of 2008 than seemed likely at the January meeting. A model estimated by our staff economists for forecasting recessions suggests a probability in the neighborhood of 60 percent that the NBER dating committee will label the current experience an official recession. Unlike some, I am not an optimist on the effect of the fiscal stimulus program on consumer demand. Economic theory and past experience with such oneoff stimulus programs do not provide a basis for assuming a strong response. In the current situation, with many consumers heavily leveraged, it is likely that the stimulus to consumption will be less than historical averages. Notwithstanding the February CPI report, the inflation situation is deteriorating and appears likely to continue deteriorating. Beyond the immediate issue of containing systemic risk, the most important issue is the subsequent economic recovery. We have eased aggressively already. We must not lose focus on the lagged effect of current policy actions on that recovery. We must preserve the credibility of our commitment to low and stable inflation. The greatest danger is a relapse into a period of higher inflation, which then promotes a policy response that could generate a future recession and start a vicious cycle of increasing inflation and increasing unemployment. Thank you, Mr. Chairman. " FOMC20080929confcall--5 3,MR. DUDLEY.," Okay. Thank you, Mr. Chairman. Let me start with the foreign exchange swap lines, and then I'll talk a bit about the TAF increases and about the balance sheet. I think Brian later is going to talk about interest on reserves in more detail. All of the foreign central banks that have obtained dollar swap lines in response to dollar funding pressures in their home markets have decided, with some encouragement on our part, to seek an increase in the size of these swap line authorizations. We just have to hear from the Bank of Japan--I think that's the only one that's outstanding--but we expect to hear that shortly. The actual draws on these lines may turn out to be considerably less, and the amounts that are actually drawn are likely to depend on market conditions. The large increase in authorization should be considered as insurance in case market conditions continue to deteriorate and as reassurance to market participants that the world's major central banks are determined to respond in force to mitigate dollar funding pressures. By foreign central banks, the current lines are being doubled for the larger participants and tripled for the smaller participants. The increases are as follows, very quickly: the Bank of Canada, $30 billion from $10 billion; the Bank of England, $80 billion from $40 billion; the Bank of Japan, $120 billion from $60 billion; the National Bank of Denmark, $15 billion from $5 billion; the ECB, $240 billion from $120 billion; the Bank of Norway, $15 billion from $5 billion; the Reserve Bank of Australia, $30 billion from $10 billion; the Swedish Riksbank, $30 billion from $10 billion; and the Swiss National Bank, $60 billion from $30 billion. Adding up all of this would result in an increase in our swap line authorization to $620 billion from $290 billion previously. I think that these decisions have been made in response to the increasing turmoil evident in interbank markets, especially for dollar funding; and by increasing the size of the authorization significantly, the intention is to reassure market participants that sufficient dollar funding will be available well into 2009. The staff believes that these large increases are appropriate to reassure market participants that the world's central banks are prepared to take extraordinary steps as needed to address ongoing strains in financial markets. These strains are evident in a number of ways. First, we've seen a sharp rise in overnight dollar funding rates and in term LIBOR�OIS spreads. For example, on Friday, the three-month LIBOR�OIS spread was over 200 basis points, and in fact, LIBOR may actually understate the degree of funding pressure. The NYFR index, which is the U.S.-based alternative to LIBOR, has actually been much higher than LIBOR over the past week or two. So LIBOR actually may be understated. Second, there have been many anecdotal reports of a withdrawal of counterparties' willingness to engage in term funding activity. So the tenor of almost all activity in the market now is overnight. Third, there are growing liquidity strains at major financial institutions. Obviously, Wachovia is part of that story. Fourth, we've seen a significant rise in the demand for our TSLF and TAF credit. For example, the stop-out rate for the most recent TAF auction, which was a 28-day maturity auction, was 3.75 percent, significantly above the one-month LIBOR rate at the time. Fifth, we've seen a sharp rise in PCF and PDCF borrowings. For example, on the week ending last Wednesday, PCF credit was $39.4 billion, an increase of about $18 billion from the previous week, and PDCF borrowing was $88 billion in the latest week, up $68 billion from the previous week. Last, European banking strains have been increasingly evident in recent days, especially this weekend following the announcement of the Fortis rescue and the nationalization of B&B in the United Kingdom. The European banking news has led to a sharp drop in the European equity markets--this morning they're down 2 to 3 percent--and the euro and sterling exchange rates have dropped quite sharply against the dollar, down about 2 percent. Now, along with this increase in authorized swap lines, Chairman Bernanke has approved the staff recommendation for a large increase in our term auction facility (TAF) program. We are proposing two changes in the TAF program. First, we're proposing to increase the 84-day TAF auction sizes to $75 billion per auction, from $25 billion. That will start with the next 84-day auction that was scheduled for October 6. The second change is that the Chairman has approved two forward TAF auctions totaling $150 billion. These auctions would take place in November, and they would auction short-dated TAF funds for one-week or two-week terms over year-end. Together, these two changes to the TAF program would increase the supply of TAF credit to $450 billion, from $150 billion currently. The notion is that a larger commitment to TAF funding should help ameliorate market concerns about the availability of term funding and about the availability of such funding over year-end. The effective dates for the swap lines and all the programs will be extended, I think, to April 30, 2009. This would enable the foreign central banks to extend 84-day TAF credit through year-end under their swap agreements. Obviously, these commitments are likely to put considerable further strain on the Federal Reserve's balance sheet. In recent days we have been offsetting the large reserve additions with the Treasury SFP (supplementary financing program) cashmanagement bill issuance. After this week's scheduled bill issuance, the total amount of outstanding SFP obligations will reach $400 billion. However, we cannot rely on this program indefinitely because the Treasury's room under the debt limit ceiling is about $900 billion as of early last week and is shrinking rapidly because of the SFP and other ongoing funding commitments. PARTICIPANT. It's impossible to hear. " CHRG-110hhrg41184--45 Mr. Bernanke," Well, we don't know what oil prices are going to do. It depends a lot on global conditions, on demand around the world. It also depends on suppliers, many of which are politically unstable or in politically unstable regions or have other factors that affect their willingness and ability to supply oil. So there's a lot of uncertainty about it, but our analysis combined with what we can learn from the futures market suggests that we should certainly have much more moderate behavior this year than we have. But, again, there's a lot of uncertainty around that estimate. " CHRG-111hhrg53021Oth--75 Chairman Frank," Well, ``premature'' is not a question. It is at least a description. Maybe the gentleman regards it as something good to be premature; I have never done that. But the point is that we are having a chance now to air the questions. I now recognize the gentlewoman from California, Ms. Waters. Ms. Waters. Thank you very much, Mr. Chairman. There is substantial attention given to OTC derivatives in your testimony. And, as you know, I have been talking a lot about credit default swaps. And I remember what you told me the last time I asked you; you said that if we ban credit default swaps, they will just emerge in another way, that the sophistication and creativity of those who deal in these markets is such that they will just find another way to do what they want to do. Basically, what I am reading from your testimony is that you think that credit default swaps are necessary. However, this country did very well without them for a long period of time. If credit default swaps do such a good job at diffusing risk, why did so many financial institutions lose so much money, even when they were using credit default swaps as a hedge? Doesn't this prove that these products are more dangerous than originally thought? And why not ban credit default swaps? " CHRG-111hhrg53021--75 Chairman Frank," Well, ``premature'' is not a question. It is at least a description. Maybe the gentleman regards it as something good to be premature; I have never done that. But the point is that we are having a chance now to air the questions. I now recognize the gentlewoman from California, Ms. Waters. Ms. Waters. Thank you very much, Mr. Chairman. There is substantial attention given to OTC derivatives in your testimony. And, as you know, I have been talking a lot about credit default swaps. And I remember what you told me the last time I asked you; you said that if we ban credit default swaps, they will just emerge in another way, that the sophistication and creativity of those who deal in these markets is such that they will just find another way to do what they want to do. Basically, what I am reading from your testimony is that you think that credit default swaps are necessary. However, this country did very well without them for a long period of time. If credit default swaps do such a good job at diffusing risk, why did so many financial institutions lose so much money, even when they were using credit default swaps as a hedge? Doesn't this prove that these products are more dangerous than originally thought? And why not ban credit default swaps? " CHRG-111hhrg53244--364 Mr. Maffei," Thank you very much, Mr. Chairman. And thank you, Chairman Bernanke, for being here and for indulging all of the members. I am the most junior member, so I presume I am the last to question. I am sure that you have seen some of the reports about credit card companies increasing their rates and charges in anticipation of the upcoming new credit card laws and Federal Reserve regulations taking effect. This seems to me to run counter to, certainly, the intent, if not the letter of the recently enacted regulations by your group and laws. We have heard that the credit card companies have asked--they asked us when we were putting the bill together, as they asked you, for a delay so that they could implement these sort of things. And instead, they seem to be using these delays to generate more profits on the backs of the consumers. Is there anything that you can do, from your perspective at the Federal Reserve, to speed up the regulations to try to take care of these people? " CHRG-111shrg55117--46 Mr. Bernanke," Not fiscal policy. We have a joint statement with the Treasury which makes clear that the Fed should not be responsible for credit allocation or fiscal policy. We are looking at financial stability. That is our objective. Senator Bunning. This question is about unbiased reports of the facts, not reports with an agenda. Are you opposed to objective external review of monetary policy and other Federal functions? If so, what monetary policy information do you not want in the hands of the public? " CHRG-111shrg57321--175 Mr. McDaniel," The credit protection levels were raised, and then the market shut down very quickly after that. Senator Kaufman. Ms. Corbet, when did you first pull your management team together and say, I don't think this is like what has happened in the past. We are producing products--way too many of our AAAs are defaulting. We should really change the way things are going. Ms. Corbet. Well, I think Standard and Poor's, concurrent with its own research and publications of some of the stresses that they were beginning to see in the marketplace back in 2005, they began to make, as earlier testified by the S&P folks, that they began to make changes in their criteria and their credit enhancement levels in 2005 and in 2006, as well. In fact, in 2006, the number of downgrades exceeded the number of upgrades for subprime residential mortgage-backed securities. So the actions were following the research and the findings that were being reported to the marketplace. In 2007, following again the two previous credit enhancement increases, again, the performance data was suggesting that it was even more serious than was previously contemplated, and so, therefore, in February 2007 S&P made another change and announcement of downgrades to--credit watch, excuse me, for subprime mortgages. In March, we reported also in a teleconference about what our outlook was in terms of expectations for the housing market and what the impact may be in terms of downgrades---- Senator Kaufman. And again, this reporting is great, but really, the key---- Ms. Corbet. Is actions, yes. Senator Kaufman. Yes. But, I mean, the key is how many AAAs are we sending out the door that in retrospect, when you look back on it 2 years later, are not AAA but they are junk? I mean, that is really the key. I think--and, Ms. Corbet, were you here for the first panel? Ms. Corbet. I was in and out, yes. Senator Kaufman. OK. That is not what they said in the first panel. They said a number of things, and what I would like to do is kind of go through them and see what you say. They said it was incentives. Ms. Corbet. Yes. Senator Kaufman. Mr. McDaniel, they said that there were incentives in the organization, in Moody's, to get more business out the door, to not worry so much about what the rating is going to be, just move it out there, quantity over quality, I think, is the term that one of the gentlemen used. Clearly, you haven't raised that as one of the problems. " FinancialCrisisReport--115 Ms. Feltgen’s dedication to the growth of the Home Loans business is apparent in her communications with her staff. For example, on December 26, 2006, she sent a year-end email to her staff. Under the subject line, “Year-End 2006 Message for the Home Loans Risk Management Team,” Ms. Feltgen wrote: “As we approach the close of 2006, it is fitting to reflect on the challenges and accomplishments of this past year and to look forward to 2007 and beyond. Earlier this year David Schneider and the leadership team of Home Loans articulated a new business strategy that included: (1) a shift to higher margin products (Alt-A, subprime and home equity); (2) reducing market risk … and taking on more credit risk and (3) aggressively attacking the cost structure. We have made great strides as a business on all of those fronts and you have all been a part of those accomplishments. You have partnered successfully with the business units of Home Loans in pursuit of our collective goal to drive profitable growth with the right balance of risk and return.” 405 The email continued with a list of “accomplishments of the Home Loans Risk Management Team in support of business goals,” that included the following accomplishment: “Our appetite for credit risk was invigorated with the expansion of credit guidelines for various product segments including the 620 to 680 FICO, low docs and also for home equity.” 406 The email continued with Ms. Feltgen stating her commitment to the High Risk Lending Strategy and emphasizing revenue and sales despite an acknowledgement of the worsening condition of the mortgage market: “The year 2007 will be another challenging year for the mortgage industry with mortgage origination volumes down, the inverted yield curve putting pressure on profitability and gain on sale margins at lower level than prior years. The focus on the three key elements of our 2006 strategy remains important: shift to higher margin products, reduce market risk and increase credit risk and attack the cost structure. … In 2007, we must find new ways to grow our revenue. Home Loans Risk Management has an important role to play in that effort. David Schneider has encouraged us to ‘BE BOLD’…. Recognize that ‘we are all in sales’ passionately focused on delivering great products and service to our customers.” 407 Ms. Feltgen’s year-end bonus was based upon her performance review. 408 According to Mr. Cathcart, in 2007, the bank made bonus distributions more dependent on the performance of 405 1/3/2007 email from Cheryl Feltgen, “Year-End 2006 Message for the Home Loans Risk Management Team,” Hearing Exhibit 4/13-73. 406 Id. 407 Id. 408 Subcommittee Interview of Ronald Cathcart (2/23/2010). each business line, rather than the performance of the bank as a whole, which largely removed his control over compensation of his risk managers. Mr. Cathcart told the Subcommittee that he disagreed with this change because it made his risk managers, who reported to him and to the heads of the business units, more beholden to the business heads. Mr. Cathcart said he approached the head of Human Resources, and strongly objected to the change, but was told to take it up with Mr. Killinger. Mr. Cathcart told the Subcommittee that he voiced his objection to Mr. Killinger, but Mr. Killinger told him to talk to Mr. Rotella. He said that he took his objection to Mr. Rotella, but was unsuccessful at preventing the policy change. FOMC20080130meeting--19 17,MR. POOLE.," If I may make a comment about that--I think everyone is aware of my view that the TAF does not change the marginal conditions. It's entirely an inframarginal operation. What it does is to save banks the spread between what their cost of funds otherwise would be and what they get at the TAF. So it increases bank earnings by that amount. It seems to me that there is potentially some reputational risk to the Federal Reserve in the long run if a significant share of the benefit is going to foreign banking organizations. I guess one question that I would pose is, If we think that this information would be terribly sensitive to release, shouldn't we be careful about whether we continue if the foreign banking organizations are taking a very large fraction? " FOMC20060808meeting--161 159,MR. MOSKOW.," Thank you, Mr. Chairman. I’ll comment on just three areas, in the spirit of being general here. First, on the goals—I thought the goals that you put into the document you distributed were very good. They were very well stated and had an appropriate balance. I didn’t think that they constrain open discussion at the meetings. The communication of uncertainty and conditionality is difficult, but part of our goal should be to do it better. Second, on the quantity of information and the forward-looking content—that whole series of questions that you asked—I’d divide my comments into two parts. One, if we do go with some type of quantitative guideline, we will need to release more information. We’d need something like an inflation report, maybe quarterly, such as other central banks have, just to explain and elaborate on the guideline and how the economy was doing versus that quantitative guideline. I don’t think we could just stay with the twice-a-year report that we give now in detail. Third, we should talk about longer-term forecasts than we do now. That’s an important part of this. In fact, if this Committee decides not to go with quantitative guidelines, we could accomplish many of the objectives by just having longer-term forecasts for the economy. If we did these longer-term forecasts, we’d have to address many of the issues that are discussed in the sections here—the policy assumption question, for example. We now do that based on appropriate policy, but we could do that in different ways. But the longer forecasts would allow us to convey policy goals, to discuss expected paths to achieving those goals, and to take into account the range of opinions regarding the paths and goals without necessarily having us agree to a quantitative guideline. At this point, I’m agnostic on the question of whether we should have a quantitative guideline. I should say that I really haven’t decided yet and that the topic is for further discussion. In any case, longer-term forecasts would be one option to consider if we did not go with a quantitative guideline. Of course, if we did go with a quantitative guideline, we could also have longer-term forecasts. But I think the longer-term forecasts would help us improve our formulation of monetary policy, either with or without a quantitative guideline. I want to mention just one other point about the policy conditioning. I hope someone could do research on the Bank of England approach. Don, I know you’ve been there. They present a forecast conditioned on the market expectations for policy interest rates. They also do an alternative based on an unchanged rate path. They’ve given us an example of one case in which the forecast based on the market showed that inflation would be outside the guideline when they published it, and the market immediately reversed its view as to what the Bank of England was able to do on policy without the Bank’s saying anything. Just the publication of that forecast itself accomplished a lot of their objective. Of course, we’d have to be explicit about the technical details underlying the market expectations of the forecast, but that’s sort of a technical part of this. We’re off to a good start, and I particularly like the goals that you set forth." CHRG-109hhrg23738--109 Mr. Paul," Thank you, Mr. Chairman. If indeed this is your last appearance before our committee, Mr. Greenspan, I would have to say that in the future I am sure I will find these hearings a lot less interesting. [Laughter.] But I do have a couple of parting questions for you. Keynes, when he wrote his general theory, made the point that he had a tremendous faith in central bank credit creation because it would stimulate productivity. But along with this, he also recognized that it would push prices and labor costs up. He saw this as a convenience, not a disadvantage, because he realized that in the corrective phase of the economic business cycle, that wages had to go down, and people would not accept a nominal decrease in wages; but if they were decreased in real terms, it would serve the economic benefit. Likewise, I think this same principle can be applied to our debt. To me, this system that we have today is a convenient way to default on our debt, to liquidate debt through the inflationary scheme. Even you, in the 1960s, described the paper system as a scheme for the confiscation of wealth. And in many ways I think this is exactly what has happened. We have learned to adapt to deficit financing, but in many ways the total debt is not that bad because it goes down in real terms. As bad as it is, in real terms it is not nearly as high. But since we went on a total paper standard in 1971, we have increased our money supply essentially 12-fold. Debt in this country, federal debt, has gone up 19-fold; but that is in nominal dollars, not in real dollars. So my question is this: Is it not true that the paper system that we work with today is actually a scheme to default on our debt? And is it not true that, for this reason, that is a good argument for people not--eventually, at some day--wanting to buy Treasury bills because they will be paid back with cheaper dollars? And indeed in our lifetime we certainly experienced this in the late 1970s, that interest rates had to go up pretty high, and that this paper system serves the interests of big government and deficit financing because it is a sneaky way of paying for deficit financing. At the same time, it hurts the people who are retired and put their money in savings. And aligned with this question, I would like to ask something dealing exactly with gold: If paper money--today it seems to be working rather well, but if the paper system does not work, when will the time come, what will the signs be, that we should reconsider gold? Even in 1981, when you came before the Gold Commission, people were frightened about what was happening, and that was not too many years ago, and you testified that it might not be a bad idea to back our government bonds with gold in order to bring down interest rates. So what are the conditions that might exist for the central bankers of the world to reconsider gold? We do know that they have not given up on gold. They have not gotten rid of their gold. They are holding it there for some reason. So what is the purpose of the gold if it is not with the idea that someday they might need it? They do not hold lead or pork bellies; they hold gold. So what are the conditions that you might anticipate when the world may reconsider gold? " FOMC20081216meeting--78 76,MR. LOCKHART.," Thank you, Mr. Chairman. I add my thanks to the staff for the excellent summaries, particularly those that covered the Japanese experience. My reading of that experience argues for acting aggressively and moving directly to whatever lower bound we consider the effective minimum. The economic outlook has deteriorated sharply, and as I look at the incoming data and our near-term forecasts, I find it reasonable to expect that we will see more troubling data by the time of our January meeting. I concur with the Greenbook assessment that the outlook calls for a cumulative reduction of 75 basis points over the next two meetings. At the risk of jumping ahead a little, my preference is to get there at this meeting. If there is an argument for a more gradual two-step approach, it is that more communication is needed to explain the Committee's strategy and condition the markets for a zero lower bound policy regime. I was on the receiving end of this argument at my Atlanta board meeting last week--which Don Kohn witnessed as a guest--at which some directors strongly resisted moving to the lower bound without, in their view, a clearly articulated statement about how policy will operate going forward. Mr. Chairman, in your speech two weeks ago you made a good effort to prepare the public for the possibility that the Committee may soon have to operate with policy targets that are unfamiliar. But it strikes me that there is a chicken�egg problem of when it is appropriate to lay out the new approach. Again, I read the Japanese lesson as move aggressively but at the same time communicate very clearly the whys and hows of the policy course. President Plosser pointed out in his memo circulated last week--and I believe President Lacker noted last meeting--that we have at least implicitly entered into a quantitative easing regime already. The fed funds rate has been trading for some weeks near the level that we are likely to find as the lower bound. I think we must move to a decision at this meeting on communication strategy, independent of whether or not we move to the lower bound in one step. I don't see that this need is significantly reduced by delaying the move to the lower bound, especially if that destination is inevitable, as I believe it to be. On the question of costs of the zero lower bound policy to markets and financial institutions, in my reading of the analysis and the background memos taken as a whole, maintaining the effective funds rate at a level somewhere near 25 basis points may help avoid problems in some markets that would otherwise arrive at zero. I think we have to be concerned that at absolute zero the infrastructure of some markets might atrophy as market participants shift resources in the direction of operations where profits are more attainable. These concerns might argue for stating the federal funds rate target in terms of a range, and I would support a lower bound in the range of 0 to 25 basis points. As regards communication strategies, to state the obvious, financial market participants would prefer to know as much as possible about the level of rates in a zero lower bound regime, the duration of adherence to that policy, and when and on what basis the policy will change. The Committee can't fully satisfy those needs, but we can provide assurances that equip market participants with a clear framework for planning and anticipating change of policy. I think it is important to communicate that we intend to stay the course with this policy until some combination of materially improved conditions obtain in both financial markets and the general economy. That is to say, we should indicate that the policy is not short-term shock treatment to be quickly reversed, unless, of course, conditions dictate. As regards indicating specific conditions that would inform a change of policy or a change of course, I favor an approach that addresses conditionality in general terms using language such as ""the Committee intends to hold the federal funds rate target at this level until such time that it judges conditions are present for material and sustained improvements in financial market functioning and economic growth."" I prefer to reference general economic conditions rather than to use phrases like ""near zero for some time"" as in Bluebook alternative B. Further, I think it is appropriate to reinforce that our policy will be calibrated based on our longer-term inflation objectives. I am not comfortable with formal statements indicating that the Committee is willing to accept higher rates of inflation than it normally would find desirable. In my view, the goal is to avoid entrenching expectations that deviate too much from our explicit or implicit price stability objectives in both inflationary and deflationary directions. I think this goal is best pursued by stating our commitment to medium-term price stability. This statement can be in general terms, but I would also support the more explicit numerical reference in Bluebook alternative A. As regards more purchases of agency debt, agency MBS, and long-dated Treasuries, my view is that open market operations should be conducted in the manner that enhances overall market liquidity in the most efficient and least disruptive way. This may well be by purchases of agency debt and MBS beyond the level announced. However, to the extent that enhancing overall market liquidity requires efforts to directly manipulate prices in particular markets beyond the federal funds market, I think we may be better served by developing specifically targeted facilities to do so. As regards the further expansion of liquidity facilities, to date we have attacked dysfunctional market conditions in the interbank funding market, the Treasuries market, the commercial paper market, the mortgage market, and, shortly, the asset-backed securities market. The more we migrate with these facilities in the direction of general corporate debt and other nonfinancial issuers' markets, the more our policy actions involve contentious issues of moral hazard, possible distortion of the necessary process of relative price discovery, and the appropriate division of labor between the central bank and the Treasury. I think that we just need to keep this in mind as new facilities are considered. The extension and broadening of existing facilities, and possibly new facilities, may be necessary. I judge that the broad policy of targeted facilities has been successful to date. Regarding nonstandard tools, I find myself in agreement with the thrust of President Plosser's suggestions. In a quantitative easing regime, it makes most sense to express our directive in terms of a quantitative target. And as regards your comments earlier, Mr. Chairman, I tend to look at this target question as a tradeoff between targeting quantities versus prices or rates, and I believe that the quantitative target approach is the correct approach, even if we decide to operate with the common understanding that our short-term objective is, for example, to generate a particular path for long-term Treasuries or agency debt. Based on my reading of the literature and history as well as on my own experience, I have doubts about our capacity to reliably control specific relative asset prices, at least in markets unlike the federal funds market, where we are the monopoly supplier of the asset being traded. But that does not preclude setting quantitative targets for the purchase of particular assets and evaluating the appropriateness of those targets against a variety of outcomes, including the interest rates that emerge in those markets. I am, however, predisposed toward the line of thinking expressed by President Lacker in his pre-meeting memo. By choosing to express the directive in terms of the monetary base or some measure of reserves, the decisions of the Committee remain in the range of traditional monetary policy. My conjecture is that a reserve base quantitative directive would help to draw a clear line between traditional monetary policy decisions in the purview of the FOMC and the enhanced credit policies implemented under 13(3) authority. Let me move to the communication approaches. Again, internalizing the Japanese experience, we will be well served by a significant and coordinated communication effort. Our press statement might be supplemented by an additional explanation of whatever new operational procedures we adopt, followed by a public statement, perhaps even a press conference, by the Chairman. Throughout this crisis, we have been provided excellent support in the form of talking points. These have been a great help to me and my staff in providing accurate and timely information on the various policy actions taken by the Federal Reserve. With similar assistance in this case, I think we can collectively commit to providing the sort of common voice on the facts that will promote public understanding of the direction in which we decide to head. Thank you, Mr. Chairman. " CHRG-110hhrg46596--245 Mr. Hinojosa," But you should know that this sector is huge; there was over $16 billion that was lent out in college loans. And to have banks not offering credit, not offering these student loans not only for the cars and for appliances and for many things that you have heard from my colleagues before me, these student loan programs are not working right now. And you need to know and have people report back to you on how it is not fixing the problem. I would like to ask Comptroller General Dodaro, the TALF program's aim was to increase credit availability for credit cards, auto loans, and student loans, as I mentioned. However, private lenders of the non-Federal student loans already enjoy Federal protections that auto and credit lenders do not, making it nearly impossible for student borrowers to discharge private student loans in bankruptcy. How will TALF program take into consideration these differences in the treatment of consumer debt? " FinancialCrisisReport--310 Similarly, Ernestine Warner, the head of RMBS Surveillance, lost her managerial position and was reassigned to investor relations in the Structured Finance Group. On July 10, 2007, amid record mortgage defaults, S&P abruptly began downgrading its outstanding RMBS and CDO ratings. In July alone, it downgraded the ratings of more than 1,000 RMBS and 100 CDO securities. Both credit rating agencies continued to issue significant downgrades throughout the remainder of 2007. On January 30, 2008, S&P took action on over 8,200 RMBS and CDO ratings – meaning it either downgraded their ratings or placed the securities on credit watch with negative implications. These and other downgrades, matched by equally substantial numbers at Moody’s, paint a picture of CRA surveillance teams acting at top speed in overwhelming circumstances to correct thousands of inaccurate RMBS and CDO ratings. When asked to produce contemporaneous decision-making documents indicating how and when the ratings were selected for downgrade, neither S&P nor Moody’s produced meaningful documentation. The facts suggest that CRA surveillance analysts with already substantial responsibilities and limited resources were forced to go into overdrive to clean up ratings that could not “hold.” (6) Mortgage Fraud A final factor that contributed to inaccurate credit ratings involves mortgage fraud. Although the credit rating agencies were clearly aware of increased levels of mortgage fraud, they did not factor that credit risk into their quantitative models or adequately factor it into their qualitative analyses. The absence of that credit risk meant that the credit enhancements they required were insufficient, the tranches bearing AAA ratings were too large, and the ratings they issued were too optimistic. Reports of mortgage fraud were frequent and mounted yearly prior to the financial crisis. As noted above, as early as 2004, the FBI began issuing reports on increased mortgage fraud. 1202 The FBI was also quoted in Congressional testimony and in the popular press about the mortgage fraud problem. CNN reported that “[r]ampant fraud in the mortgage industry has increased so sharply that the FBI warned Friday of an ‘epidemic’ of financial crimes which, if not curtailed, could become ‘the next S&L crisis.’” 1203 In 2006, the FBI reported that the number of Suspicious Activity Reports on mortgage fraud had increased sixfold, from about 6,800 in 2002, to about 36,800 in 2006, while pending mortgage fraud cases nearly doubled from 436 in FY 2003 to 818 in FY 2006. 1204 The Mortgage Asset Research Institute, LLC (MARI) also reported increasing mortgage fraud over several years, including a 30% increase in 2006 alone. 1205 1202 FY 2004 “Financial Institution Fraud and Failure Report,” prepared by the Federal Bureau of Investigation, available at http://www.fbi.gov/stats-services/publications/fiff_04. 1203 “FBI warns of mortgage fraud ‘epidemic’,” CNN.com (9/17/2004), http://articles.cnn.com/2004-09- 17/justice/mortgage.fraud_1_mortgage-fraud-mortgage-industry-s-1-crisis?_s=PM:LAW. 1204 “Financial Crimes Report to the Public: Fiscal Year 2006, October 1, 2005 – September 30, 2006,” prepared by the Federal Bureau of Investigation, available at http://www.fbi.gov/stats- services/publications/fcs_report2006/financial-crimes-report-to-the-public-2006-pdf/view. 1205 4/2007 “Ninth Periodic Mortgage Fraud Case Report to Mortgage Bankers Association,” prepared by Mortgage Asset Research Institute, LLC. CHRG-110shrg50420--92 Mr. Kepplinger," That was a specific condition that was included in the extension of the loan guarantees. To read from the statute, the board had to determine that there was no substantial likelihood that Chrysler Corporation will be absorbed by or merged with any foreign entity, and that is, of course, a judgment that you all will have to make. Senator Menendez. And one final question. Have you looked at this point in your--I know you got brought in rather late, but have you looked at the presumptions of the Big Three in terms of what their projections are as it relates to viability? Have you had that opportunity? " FOMC20080130meeting--73 71,MR. REIFSCHNEIDER.," 2 Give me one second. On balance, the news we have received since the December Greenbook has been disappointing. The top panel of your first exhibit sorts some of the main indicators into two categories--those that were surprisingly weak and those that came in to the upside of our expectations. As you can see, the list to the left is long. Private payrolls fell in December, and the unemployment rate jumped to 5 percent. Manufacturing output has declined since the summer. Single-family housing starts, new permits, and home sales have fallen further. New orders and shipments of capital goods were disappointing, although a little less so after today's release of December data. Business sentiment deteriorated, joining already unusually low readings on consumer confidence. Finally, stock prices have tumbled, and credit conditions have tightened. Not all the news was bad. Nonresidential construction activity has continued to be surprisingly robust, and defense spending looks to have been higher last quarter than we anticipated. Moreover, retail sales in November came in stronger than we predicted, and the figures for September and October were revised up. Overall, we read the incoming 2 The materials used by Mr. Reifschneider, Ms. Liang, and Mr. Sheets are appended to this transcript (appendix 2). data as implying an increased risk of recession. The middle left panel provides some evidence for this assessment. As was discussed at yesterday's Board briefing, based on the signal provided by 85 nonfinancial indicators (the black line), the estimated probability of being in recession now or over the next six months stood at 45 percent in December, up from 19 percent in June. A similar exercise carried out using 20 financial indicators, the red line, yields an even bigger jump in the estimated likelihood of recession, from 14 percent at midyear to 63 percent this month. As you know, we are not forecasting a recession. While the model estimates of the probability of recession have moved up, they are not uniform in their assessment that a recession is at hand. Another argument against forecasting recession is that, with the notable exception of housing, we see few signs of a significant inventory overhang. In addition, the recent weakness in the labor market and spending indicators is still limited; for example, initial claims have drifted down in recent weeks rather than surging as they typically do in a major downturn. Finally, a good deal of monetary and fiscal stimulus is now in process that should help support real activity. That said, it was a close call for us. Even without a recession, our assessment of the underlying strength of aggregate demand has revised down markedly since the summer. This is illustrated in the bottom panel by the recent decline in the Greenbook-consistent estimate of short-run r*, the value of the real funds rate that would close the output gap in 12 quarters. By our estimate, short-run r* has fallen more than 2 percentage points since the middle of last year and 1� percentage points since December. A jump in the equity premium accounts for most of the downward revision since the last Greenbook, although a further deterioration in the outlook for residential investment is also a factor. Your next exhibit summarizes the current forecast. So, how did we respond to all this bad news? As shown in the panel at the top, we boosted real GDP growth a little from 2007 through 2009. In 2008 and 2009, however, this faster growth is not demand driven but instead reflects upward revisions to the supply side of our forecast that I will discuss in a moment. For 2007, the upward revision to real GDP in the fourth quarter--noted in the panel to the right--reflects the stronger data on nonresidential construction, defense spending, and retail sales that I just mentioned. However, because the incoming data point to a weaker trajectory for real activity in the near term, we have trimmed our forecast of GDP growth for the first half of 2008, and we have marked down final sales growth (not shown) quite a bit. Beyond the middle of the year, we project real output to expand at a rate close to its potential. Under these conditions, we project greater labor market slack than in December, with the unemployment rate--shown in the middle left panel--now expected to edge up to 5� percent by next year. And as shown in the bottom two panels, we continue to expect both core and total PCE prices to decelerate noticeably by 2009, although inflation this year is likely to run a little higher than we previously projected. Your next exhibit provides an overview of some of the key factors influencing the outlook. As shown in the upper left panel, we conditioned our forecast on an additional 50 basis point cut in the funds rate at this meeting and then held it flat at 3 percent. We made this revision in response to the weaker underlying level of demand in this projection but with an eye to keeping inflation on a long-run path to 1� percent--the midpoint of the range of 2010 inflation projections that you provided in October. Another key element in the outlook is our assumption that concerns over financial stability and a possible recession will begin to abate once the economy gets through a rough patch in the first half of this year. As Nellie will discuss in more detail, this assumption implies that risk premiums on bonds and corporate equity should drift down over time. As a result, we project that equity prices, shown to the right, will stage a partial recovery over the second half of 2008 and in 2009. These and other financial market developments, coupled with an improvement in business and consumer sentiment, should help to support consumption and investment over time. As regards fiscal policy, odds now seem high for the passage of a fiscal stimulus package, although the details are still up in the air. As a placeholder, we built a $125 billion package into the baseline, with two components--$75 billion in tax rebates that households will receive in the third quarter and a 30 percent one-year bonus depreciation allowance that should cost the Treasury about $50 billion in 2008. Our judgment is that the rebate component will provide a significant, albeit temporary, boost to the level of consumer spending during the second half of this year and in early 2009, the period over which we expect most households to spend their checks. In contrast, we think that bonus depreciation will have only a small effect on equipment and software outlays. As indicated by the blue bars in the panel to the right, these assumptions imply a large fiscal-driven contribution from PCE and E&S to real GDP growth in the second half of this year, followed by a similar-sized negative contribution in the first half of 2009. As a result, the long-run contribution to real GDP growth from these two factors is essentially zero. We have assumed that inventories and imports in the short run will offset a substantial fraction of the swings in domestic demand, thereby muting the overall effect of the fiscal package on real GDP growth (the green bars). As I noted earlier, we also have reassessed our supply-side assumptions--shown in the bottom left panel. Specifically, we have raised our estimate of potential output growth from 2005 to 2009 about � percentage point per year, partly in response to the solid gains in output per hour recorded last year. These revised estimates have two important implications. First, the upward revision to potential output translates roughly one for one into faster growth in actual output during the projection period because of its implications for permanent income and hence consumption and investment. Second, the revisions to potential output in history imply that the output gap--shown to the right--currently is lower than we previously thought, and we expect it to remain lower. Your next exhibit provides some details on the real-side outlook. As shown in the top left panel, we have once again revised down the projection for new home sales in light of weak incoming data, including those received after we put the Greenbook to bed. However, we continue to expect that sales will reach bottom in the first half of this year and then begin to edge up as mortgage credit availability improves. This stabilization in demand should allow single-family housing starts (shown to the right) to level out at about 660,000 units by midyear, well below our December projection. Thereafter, we anticipate a slow pickup in starts. As shown in the middle left panel, builders still have a long way to go to bring the backlog of unsold homes down to a more comfortable level, and this overhang should restrain construction activity into next year. We have also revised down the near-term outlook for real business fixed investment--the middle right panel--in response to slowing sales, tighter credit conditions, and some deterioration of business sentiment, but we now expect a greater cyclical rebound starting in the second half of this year as overall conditions start to improve. The bottom left panel shows our projection for consumption, the blue bars, together with the profile for spending excluding the effects of fiscal stimulus, the green bars. Absent the stimulus package, we would expect consumer spending to increase only 1 percent this year but then to pick up around 2� percent in 2009 as confidence recovers and credit conditions ease. However, the tax rebates will likely obscure this cyclical pattern by inducing saw-tooth swings in spending, with actual growth realigning with longer-run fundamentals only in the second half of next year. As shown to the right, some of these fundamentals are less favorable than before; we estimate that wealth effects will hold down PCE spending growth by � percentage point this year and almost � percentage point in 2009. Your next exhibit reviews the inflation outlook. As indicated by the blue line in the upper left panel, monthly readings on core PCE inflation have moved up since the summer. We are inclined to take only a small signal from this movement, much as we did early last year when price increases were unusually subdued. In part, this is because a portion of the recent pickup was attributable to the erratic nonmarket component and quarter-to-quarter fluctuations in this category tend to fade away quickly. In addition, while market-based prices also came in higher than expected, we are interpreting some of that surprise as a reversal of some earlier low readings in particular categories. That said, we also think that a portion represents somewhat more persistent inflation pressure coming into 2008. We project both core and total PCE inflation to moderate over time because of several factors. To begin with, futures prices for crude oil imply the sharp deceleration in energy prices shown to the right. We also expect food prices (the middle left panel) to decelerate into 2009, partly as result of the increased production of beef and poultry that is now under way. In addition, the impetus to inflation from core import prices (the middle right panel) should diminish over time, although by less than projected in December because we now anticipate a faster rate of dollar depreciation. These developments, coupled with the additional economic slack built into this projection, should help to keep inflation expectations anchored, allowing actual inflation to fall below 2 percent in the longer run. Indeed, survey measures of long-run inflation expectations (the blue and red lines of the bottom left panel) remain stable. TIPS inflation compensation (the black line) jumped following the intermeeting fed funds rate cut, as Bill pointed out. But as was discussed in the memo by Jonathan Wright and Jennifer Roush that was circulated to the Committee, we are inclined to attribute most of this increase to changes in inflation risk and liquidity premiums, not to a rise in inflation expectations per se. Putting all this together, we project core inflation--the first column of the panel to the right--to remain at 2.1 percent this year but then to drop down to 1.9 percent next year, the same as in December. Similarly, we continue to expect that headline inflation will slow to 2� percent this year and slide to 1� percent in 2009 as energy prices moderate. I will now turn the floor over to Nellie. " FOMC20080430meeting--110 108,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. In terms of markets, Fed credibility, and negative surprises on the data relative to our forecasts, I think this has been the best intermeeting period in a long time. The markets reflect increased confidence that policy will be effective in mitigating the risks both of a systemic financial crisis and of a very deep, protracted recession. We have seen a substantial upward movement in the expected path of the fed funds rate and in real forward rates, significant diminution in the negative skewness in fed funds rate expectations, and a significant move down in a range of different measures of credit risk premiums, and markets have been pretty robust despite bad news over the past few weeks or so. Medium- and long-term expectations in TIPS have moved down, and we have had a very important and substantial additional wave of inflow of equity into the financial system. Our forecast, though, is roughly the same as it was in March, and it is broadly similar to the path outlined in the Greenbook. We expect economic activity to follow a path somewhere between the last downturn--a relatively mild downturn--and that of 1990. We expect underlying inflation to moderate somewhat over the forecast period to something below 2 percent. We see the risks to the growth forecast still skewed to the downside, though somewhat less so than in March, and we see the risks to the inflation outlook as broadly balanced. Uncertainty around both paths, though, is unusually high. I want to make four points. First, on economic growth, again, I still think we face substantial risk in this adverse self-reinforcing interaction among falling house prices, slower spending, and financial headwinds. Even with the very substantial adjustment in housing construction that has already occurred and even if demand for housing stays stable at these levels, we still have several quarters ahead of us before the decline in housing prices starts to moderate. A further falloff in aggregate demand during this period would raise the prospect of a much larger peak-to-trough decline in housing prices, with higher risk of larger collateral damage to confidence, spending, credit supply, et cetera. Weakness, as the Chairman has reminded us several times over the past few years, tends to cumulate and spread in these conditions, and weakness may only just be beginning outside of housing. The saving rate here may have to rise substantially further. The world is behind us in this cycle, and it is likely to slow further, diminishing potential help from net exports going forward. Second, financial conditions are, I think, still very fragile. The financial system as a whole still looks as though it is short of the capital necessary to support growth in lending to creditworthy households and borrowers. Parts of the system still need to bring leverage down significantly. Liquidity conditions in some markets are still impaired; securitization markets are still essentially shut. I think the markets now reflect too much confidence in our willingness and ability to prevent large and small financial failures. We are going to disappoint them on the small ones, which may increase the probability they attach to the large. At least I hope we disappoint them on the small ones. Third, I think the inflation outlook, as many of you have said, still has this very uncomfortable feel to it--very high headline inflation, very high readings on the Michigan survey, and the dollar occasionally showing the spiral of feeding energy and commodity prices and vice versa. I sat next to Paul Volcker when he gave his speech in New York the other day, and he said that the world today feels as it did in the 1970s. I was alive in the 1970s, but only just. [Laughter] But I think it is better than that. It has to be better than that. Core has come in below expectations. David is not going to explain all of that away by these temporary, reversible factors. You have all acknowledged that there is somewhat of an improvement in inflation expectations at medium-term horizon. It is very important that you have not seen any material pressure in broad measures of labor compensation. Profit margins are coming down, but they are still unusually high. The path of output relative to potential, both here and around the rest of the world, is going to significantly diminish pressure on resource utilization going forward even if you have other forces that push up demand for energy and food secularly. I think it is worth remembering that we had a very, very large sustained relative price shock in the years preceding this downturn, with very little pass-through to core inflation. In fact, in many ways, core inflation moderated over that period with output to potential much tighter. Fourth, on monetary policy, it seems to me that we are very close to a level that should put us in a good position to navigate these conflicting pressures ahead. What matters for the outlook is the relationship between the real fed funds rate and our estimates of equilibrium. Although we can't measure the latter with any precision, those estimates of equilibrium have to be substantially lower than normal because of what is happening in financial markets. The Greenbook and Bluebook presentations suggest that the real fed funds rate now is about at equilibrium. You can look at it through a number of prisms and see some accommodation--see the real fed funds rate somewhat below equilibrium now. We won't know the answer until this is long over. I think that we are probably now within the zone where we are providing some insurance against the risk of a very bad macroeconomic financial outcome without creating too much risk of an inflation spiral. We should try for an outcome tomorrow in our action and in our statement that is pretty close to market neutral. One final point about the future. What strikes me as most implausible in our forecast in New York, and I think in the average of our submissions, is the speed with which we expect to return to growth rates that are close to estimates of long-term potential. A more prudent assumption might be for a more protracted period of below-trend growth for a bunch of familiar reasons. I don't know if that is the most likely outcome, but it is a plausible and realistic outcome. I don't think we should be directing policy at trying to induce an unrealistically quick return to what might be considered more-normal growth rates over time. Thank you. " CHRG-111shrg50815--119 ZYWICKI Q.1. Access to Credit: A potential outcome of the new rules could be that consumers with less than a 620 FICO score could be denied access to a credit card. Such an exclusion could affect 45.5 million individuals or over 20 percent of the U.S. population. Without access to traditional credit, where do you believe that individuals would turn to finance their consumer needs? A.1. This is the most worrisome aspect of well-intentioned consumer credit regulations that will have unintended consequences of driving borrowers, especially credit-impaired borrowers, to other less-attractive forms of credit. Those who ore unable to get a credit card will likely be forced to turn to alternatives such as payday lending. Those unable to get credit from a payday lender will likely be forced to turn to pawn shops. And those who are unable to gain access to pawn shop credit may find themselves unable to get legal credit at all. Consumers often have emergencies or necessities for which they need credit. For instance, a young person needs credit to start a life away from home--clothes for a job, furniture for an apartment, etc. Consumers may have emergencies such as car repairs, for which they will have to find credit somewhere. If good credit is not available consumers will turn toward less-attractive terms of credit instead. Q.2. Benefits of Credit Card Use: Professor Zywicki, in previous testimony you suggested growth in credit cards as a source of consumer credit has replaced installment lending, pawnshops, and payday lending. I am concerned that the newly finalized rules may result in a lack of available consumer credit. I believe that there were clearly some egregious practices that the Federal Reserve and others should appropriately eliminate, but many who have criticized the credit card industry for facilitating excessive consumer debt, fail to point out the benefits of open access to consumer credit. Does the consumer benefit from access to open ended consumer credit over other less regulated forms of credit such as pawn shops, payday lenders, and installment lending? A.2. Consumers absolutely benefit from access to open-ended consumer credit. The dramatic growth in credit card use in recent decades testifies to this fact. Installment lending, such as retail store credit is limited because it requires consumers to ``buy'' goods and credit as a bundle. Personal finance company loans are typically both more expensive for the buyer to apply for, offer higher interest rates and other costs, and impose a rigid repayment schedule. A borrower also might be unable to get a personal finance company loan at the moment that he needs it. Payday lending and pawnshops are obviously inferior to credit cards and these other options. Credit cards offer consumers many benefits that these other products do not. Credit cards have flexible use and repayment terms. Borrowers can pay as much as they want and can switch easily among alternative card issuers. They are also generally acceptable, thereby allowing the unhooking of the credit transaction from the goods transaction. This allows consumers to shop more vigorously in both markets. General-acceptance credit cards also permit small businesses to compete on an equal footing with large businesses and department stores by relieving those small businesses of the risk and cost of maintaining their own in-house credit' operations. According to one survey conduct by the Federal Reserve, 73 percent of consumers report that the option to revolve balances on their credit cards makes it ``easier'' to manage their finances versus only 10 percent who said this made it ``more difficult.'' Durkin, Credit Cards: Use and Consumer Attitudes at 623. Q.3. Risk-Based Pricing: Banks need to make judgments about the credit-worthiness of consumers and then price the risk accordingly. Credit cards differ from closed-end consumer transactions, such as mortgages or car loans, because the relationship is ongoing. I am concerned by the Federal Reserve's new rules on risk-based repricing for a couple of reasons. First, without the ability to price for risks, banks will be forced to treat everyone with equally stringent terms, even though many of these individuals perform quite differently over time. Second, without a mechanism to reprice according to risk as a consumer's risk profile changes, many lenders will simply refuse to extend credit to a large portion of the population. Do you believe that consumers will have access to less credit and fewer choices because of the Fed's new rule? If so, is this a desirable outcome? A.3. This is likely to be the case, for exactly the reasons stated. If lenders are permitted only to reduce interest rates but not raise them, they will have to charge a higher interest rate to all borrowers to compensate for this risk. Moreover, this would give borrowers an opportunity to reduce their interest rates by switching to another card but lenders would be unable to raise interest rates in response to a change in the borrowers risk profile. Credit cards are structured as revolving debt for a reason: unlike other loans, it amounts to a new loan every month. Thus, every month the borrower has the option to switch to another, lower-interest card. Q.4. Bankruptcy Filings: As the recession worsens, many American families will likely rely on credit cards to bridge the gap for many of their consumer finance needs. Mr. Levitin and Mr. Zywicki, you seem to have contrasting points of view on whether credit cards actually force more consumers into bankruptcy, or whether credit cards help consumers avoid bankruptcy. Could both of you briefly explain whether the newly enacted credit card rules will help consumers avoid bankruptcy or push more consumers into bankruptcy? A.4. By making credit cards less-available and less-flexible, new stringent regulations will likely push more consumers into bankruptcy. Consumers in need of credit will seek that credit somewhere. Reducing access to good credit, like credit cards, will force these borrowers into the hands of much higher-cost credit, such as payday lenders. Moreover, credit cards are especially valuable because they provide a line of credit that the borrower can access when he needs it, such as when he loses his job and has medical bills. By contrast, if the borrower is required to apply for a bank loan after a job loss, he is likely to be rejected, which will accelerate his downward spiral. Moreover, credit cards are valuable in that they can be used to purchase almost any good or service. Again, the flexibility of credit cards is valuable to consumers. Q.5. Safety and Soundness and Consumer Protection: I believe firmly that safety and soundness and consumer protection go hand-in-hand. One needs only to look at the disaster in our mortgage markets, for clear evidence of what happens when regulators and lenders divorce these two concepts. A prudent loan is one where the financial institution fully believes that the consumer has a reasonable ability to repay. Do you agree that prudential regulation and consumer protection should both be rigorously pursued together by regulators? A.5. Yes. But not all safety and soundness issues related to consumers are also consumer protection issues. For instance, there were obviously a number of ordinary homeowners who essentially decided to act like investors with respect to their homes by taking out nothing-down, no-interest mortgages and then walking away when those homes fell into negative equity. If the consumers failed to understand the terms of those mortgages, then that is a consumer protection issue. If, however, the consumer consciously made this choice to speculate and the lender made the loan anyway, then while this would trigger a safety and soundness concern it is difficult to see how this would amount to a consumer protection issue. Q.6. Subsidization of High-Risk Customers: I have been receiving letters and calls from constituents of mine who have seen the interest rates on their credit cards rise sharply in recent weeks. Many of these people have not missed payments. Mr. Clayton, in your testimony you note that credit card lenders have increased interest rates across the board and lowered credit lines for many consumers, including low-risk customers who have never missed a payment. Why are banks raising interest rates and limiting credit apparently so arbitrarily? Does this result in low-risk customers subsidizing people who are high-risk due to a track record of high-risk behavior? A.6. Did not respond by publication deadline. Q.7. Effects on Low-income Consumers: I want to put forward a scenario for the witnesses. Suppose a credit card customer has a low income and a low credit limit, but a strong credit history. They use their credit card for unexpected expenses and pay it off as soon as possible, never incurring late fees. With the new regulations approved by the Federal Reserve, banks will be restricted in their use of risk-based pricing. This means our cardholder could see his or her interest rates and fees increased to pay for the actions of other card holders, many of whom have higher incomes. Do any of the witnesses have concerns that moving away from risk-based pricing could result in the subsidization of credit to wealthy yet riskier borrowers, by poorer but lower-risk borrowers? A.7. Interference with risk-based pricing makes it more difficult for lenders to tailor prices to the details of the behavior of particular consumers. As a result, lenders have to price card terms on less fine-grained assessments of risk. This leads to pricing risk across broader categories of borrowers, and in turn, increases the cross-subsidization among consumers. I can see no good policy reason why this should be encouraged. Q.8. Restriction on Access to Credit: One suggestion being made in order to encourage students not to become overly dependent on debt is to restrict access to credit to individuals under the age of 21. Mr. Zywicki, could you explain for the Committee the potential benefits and detriments of this policy? A.8. Benefit: A potential benefit, in theory, is that some younger consumers may avoid getting into debt trouble. I am not aware of any rigorous empirical evidence of how common this is. Detriments: There are several detriments: (1) LStudents who do not have access to credit cards may be tempted to take out more in the way of student loans. Because repayment on student loans is deferred until after graduation, this could cause students to take on more debt than they would if they had to pay some of their balance every month. (2) LEmpirical studies find that one major reason that causes students to drop out of college is a lack of access to credit. Many students eventually tire of ``living like a student,'' i.e., living in dorms and eating dorm food and Ramen noodles. They want an opportunity to have some sort of normal life, to go out to dinner every once in a while. Many students use credit responsibly and maturely and can have a happier student life experience if they have access to a credit card. (3) LMany students need access to credit. Although under the age of 21, many students essentially live on their own in off-campus apartments and the like. They need credit cards to pay for food, transportation, and the like. Thus, the rule sweeps far too broadly. (4) LSince the early 1990s, the fastest-rising debt on household balance sheets has been student loan debt. Students routinely graduate with tens of thousands of dollars in student loan debt. By contrast, very few students have more than a few thousand dollars in credit card debt. If Congress wants to seriously help indebted students, it should investigate the extraordinary level of student loan debt being accumulated. While credit cards can be a problem in some cases, the scope of the problem is dwarfed by the deluge of student loan debt. ------ RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM LAWRENCE FinancialCrisisReport--251 Arrangers. For RMBS, the “arranger” – typically an investment bank – initiated the rating process by sending to the credit rating agency information about a prospective RMBS and data about the mortgage loans included in the prospective pool. The data typically identified the characteristics of each mortgage in the pool including: the principal amount, geographic location of the property, FICO score, loan to value ratio of the property, and type of loan. In the case of a CDO, the process also included a review of the underlying assets, but was based primarily on the ratings those assets had already received. In addition to data on the assets, the arranger provided a proposed capital structure for the financial instrument, identifying, for example, how many tranches would be created, how the revenues being paid into the RMBS or CDO would be divided up among those tranches, and how many of the tranches were designed to receive investment grade ratings. The arranger also identified one or more “credit enhancements” for the pool to create a financial cushion that would protect the designated investment grade tranches from expected losses. 973 Credit Enhancements. Arrangers used a variety of credit enhancements. The most common was “subordination” in which the arranger “creates a hierarchy of loss absorption among the tranche securities.” 974 To create that hierarchy, the arranger placed the pool’s tranches in an order, with the lowest tranche required to absorb any losses first, before the next highest tranche. Losses might occur, for example, if borrowers defaulted on their mortgages and stopped making mortgage payments into the pool. Lower level tranches most at risk of having to absorb losses typically received noninvestment grade ratings from the credit rating agencies, while the higher level tranches that were protected from loss typically received investment grade ratings. One key task for both the arrangers and the credit rating agencies was to calculate the amount of “subordination” required to ensure that the higher tranches in a pool were protected from loss and could be given AAA or other investment grade ratings. A second common form of credit enhancement was “over-collateralization.” In this credit enhancement, the arranger ensured that the revenues expected to be produced by the assets in a pool exceeded the revenues designated to be paid out to each of the tranches. That excess amount provided a financial cushion for the pool and was used to create an “equity” tranche, which was the first tranche in the pool to absorb losses if the expected payments into the pool were reduced. This equity tranche was subordinate to all the other tranches in the pool and did not receive any credit rating. The larger the excess, the larger the equity tranche, and the larger the cushion created to absorb losses and protect the more senior tranches in the pool. In some pools, the equity tranche was also designed to pay a relatively higher rate of return to the party or parties who held that tranche due to its higher risk. Still another common form of credit enhancement was the creation of “excess spread,” which involved designating an amount of revenue to pay the pool’s monthly expenses and other liabilities, but ensuring that the amount was slightly more than what was likely needed for that 973 See, e.g., 7/2008 “Summary Report of Issues Identified in the Commission Staff’s Examination of Select Credit Rating Agencies,” report prepared by the SEC, at 6-10. 974 Id. at 6. purpose. Any funds not actually spent on expenses would provide an additional financial cushion to absorb losses, if necessary. CHRG-110shrg50418--291 PREPARED STATEMENT OF ALAN R. MULALLY President and Chief Executive Officer, Ford Motor Company November 18, 2008 Thank you Mr. Chairman, Senator Shelby and Members of the Committee. I appreciate the opportunity to be here with you today representing Ford Motor Company as you consider issues that are absolutely critical to this venerable American company and to the Nation. In my judgment, there are two fundamental questions on the table today: Is there a competitive and sustainable future for our domestic automotive industry? Is the provision of government assistance to help bridge the domestic auto industry through these difficult economic times more favorable to our Nation than the costs of inaction? I respectfully submit that the answer to these questions is a resounding yes. The domestic industry is increasingly more competitive and sustainable and is in many respects on par with our foreign competitors. A decision to make government assistance available makes much more sense than taking the tremendous risks to our already fragile economy that come with inaction.Ford's Competitive Transformation As you are well aware, we face serious problems in our economy, and the auto industry has been among the most heavily affected by the turmoil in the financial markets and the impact that turmoil has had on spending for consumer products. As public attention has shifted from the credit and financial institution crisis to larger economic issues, we in the auto industry find ourselves at the center of a national debate on the future of our industry. Much of the commentary I've read in the last few weeks is highly critical of our industry, and a common refrain is that our companies ``need a new business model.'' I completely agree. What many of the commentators and critics fail to recognize, however, is that we at Ford are on our way to realizing a complete transformation of our company--building a new Ford that has a very bright future. The reason I came to Ford 2 years ago after 37 years in the aerospace industry working for Boeing was because of my confidence that the incredible talent and resources of the Ford Motor Company could and should be redirected into an effort to transform Ford so it can be one of the strongest competitors in today's global automotive market. Inspired by the compelling vision outlined by our Executive Chairman Bill Ford, Ford had already begun its transformation from a company focused in this country largely on trucks and SUVs. All of our efforts over the last two years have been directed toward speeding up the transformation of Ford to a global profitable business based on the highest quality, sustainable, fuel-efficient, safe, fun-to-drive and best-value world class vehicles. With that in mind, I'd like to take a few minutes to tell you about the transformation under way at Ford to give you a vision for the future that we are creating today. Our plan for the past 2 years has been consistent. We have been aggressively restructuring to operate profitably at the current lower demand and changing model mix. We have been accelerating development of the safe, fuel- efficient, highest-quality new products that customers want and value. We have been working to finance our plan and improve our balance sheet. And we have been working together as one team--with our employees, dealers, suppliers and union partners--leveraging our global assets like never before. Our goal has been and remains to create a viable, highly focused, fully integrated Ford Motor Company--a lean enterprise delivering profitable growth for all over the long term. Restructuring. Few companies in the history of our country have restructured more aggressively. I can tell you that in my experience, the union under Ron Gettelfinger is working with us as part of the solution. In a very short period of time, working together, we have reduced excess capacity, closing 17 plants in North America--including more than one-third of our assembly plants--in the past 5 years. We have also reduced our workforce by 51,000 employees in the past three years, shrinking our hourly workforce from 83,000 to 44,000 and reducing salaried head count by around 12,000 from a base of 33,000. We negotiated a new contract with our UAW partners to begin a path toward competitiveness and offset some of the massive legacy costs that come with doing business in America for more than 100 years. Most significantly, that contract established a trust that funded our retiree health care obligation and removed the liability from Ford's balance sheet effective 2010. Ford has fully met the funding requirements associated with that agreement, including setting aside an initial $4 billion contribution in January of this year. Our agreement with the union also established an entry level wage that reduces future costs and will make us more competitive going forward longer-term. And, for the first time ever, it included no base wage increase during the 4-year period covered by the agreement. We have also been engaged in a broader effort to cut our costs, and in North America alone have reduced our costs by $5 billion compared with year-end 2005. We also plan further cost and cash improvements to offset the increasing weakness in the global automotive industry. Product. We are not simply on a journey to cut and shrink our way to profitability. Instead, we very much recognize the need for a product-led transformation, and believe we have the products to achieve just that. We have dramatically accelerated the introduction of new vehicles; 43 percent of our vehicles will be new or refreshed in 2009, and 100 percent of the Ford, Lincoln and Mercury lineup will be new or refreshed by the end of 2010 compared with 2006 models. Keenly aware that the world is changing as we transform our company, we are shifting from an emphasis on large trucks and SUVs to a more balanced portfolio that also emphasizes smaller and more fuel-efficient vehicles here in the U.S.--the same world-class small vehicles that have been so successful for us in other high-fuel-cost markets. By the end of 2010, two-thirds of our spending here will be on cars and crossovers--up from one-half today. We are delivering the best or among the best fuel economy with every new vehicle we introduce. This is possible through affordable, fuel-saving technologies like EcoBoost engines, which use gasoline turbocharged direct-injection technology for up to 20 percent better fuel economy, up to 15 percent fewer CO2 emissions and superior driving performance versus larger-displacement engines. We are doubling capacity for four-cylinder engines here to meet the consumer trend toward more efficient powertrains and vehicles. We also are doubling the number of offerings and volume of our hybrids in the next year alone, and we have a plan for delivering new electric vehicles and plug-in vehicles. Ford is taking advantage of our scale and global product strengths. We are delivering a balanced portfolio of small, medium and large cars, utilities and trucks, with a sharp focus on the Ford Blue Oval brand across the globe. Going forward, this balanced portfolio will provide the flexibility to adapt more easily to changes in our environment and to begin to grow profitably as the global economy rebounds. Our new products will be assembled in plants featuring lean manufacturing techniques, and, in nearly all facilities, flexible body shops will make them competitive with the best in the business. A number of our powertrains will be built in plants that can flex among the I4, V6, V8, or diesel engines. As we make these changes, we are fixing the fundamentals of the business, including a further significant reduction in structural costs next year. We also will continue the ongoing consolidation of our dealer and supplier network. Our plans call for reducing our supplier network by more than 60 percent and thereby improving supplier capacity utilization and financial viability. We have continued to improve quality with four consecutive years of marked progress. This is another area where much of the recent commentary has not yet caught up with reality. Most recently, Ford, Lincoln, and Mercury vehicles collectively reduced what we call ``things gone wrong''--a metric used to assess quality--by 7.7 percent compared with last year. That puts Ford's quality on par with Honda and Toyota. We achieved a leading number of top safety picks from the U.S. Insurance Institute of Highway Safety, with the 2009 Ford Flex and the 2009 Lincoln MKS recently earning top honors. This builds on Ford's achievement of having the most U.S. government five-star safety ratings in the automobile industry. The speed and breadth of our product-led transformation is demonstrated by significant actions taking place just this week. Tomorrow at the Los Angeles Auto Show, we unveil two all- new hybrids, the Ford Fusion Hybrid and the Mercury Milan Hybrid. Both beat the Toyota Camry Hybrid in fuel efficiency by at least five miles per gallon. The conventional versions of these new vehicles also beat the Camry in fuel economy. These vehicles are from the same Fusion family that is being recognized on the cover of one of the Nation's most prestigious consumer magazines for outstanding reliability and quality--quality that respected third parties now agree is on par with Honda and Toyota. Also today, Ford is submitting our application to the Department of Energy for direct loans authorized by Congress last year in section 136 of the Energy Independence and Security Act of 2007. We appreciate Congress' support for these loans, as they will provide access to lower-cost capital for retooling plants for more fuel-efficient vehicles. While no company has yet received funding through this program, we believe it will be important in the long term in deploying advanced technologies. On Friday, we end large SUV production at our Michigan Truck Plant and begin converting the facility to build fuel- efficient small vehicles. It is one of three large truck plants that we are converting to small vehicle production in the next two years. Financing Our Plan. To fund our transformation, we have taken many steps to protect Ford's liquidity position, including: Raising $23 billion of available liquidity through an enterprise-wide secured credit facility, going to the capital markets at the right time in 2006 to secure that financing. Selling Aston Martin, Jaguar, and Land Rover so that we could have an absolute laser focus on growing the Ford brand. Selling other businesses such as Hertz to aid our liquidity and to focus on our core business. Similarly, Ford Credit, our captive finance company, has consolidated abroad to preserve capital to support U.S. consumers and our Ford dealers here. Our Ford Credit team is optimistic that recent announcements from the Administration will help unfreeze the term securitization markets with the same success we have seen lately in asset-backed commercial paper markets. The consolidation efforts alone have not been sufficient to overcome the financial market disruption which has significantly diminished our access to traditional funding sources. Unsecured financing has declined dramatically during the past 12 months and impaired our ability to fully support dealer and consumer needs, or to achieve our growth objectives. Such funding is either non-existent or available today only at uneconomic terms. Securitization markets, our primary funding source, have likewise been frozen. The asset-backed commercial paper and public term securitization markets also have declined significantly, greatly impairing the company's ability to support dealer and consumer financing needs. Accordingly, many of our low-volume financing products have been eliminated or curtailed as we wait for the credit and financial markets return to some state of normalcy. Our Ford Credit team is optimistic that government assistance in the form of a purchase program for future term securitizations will allow us to continue financing consumers and dealers. The CPFF has been successful in this regard for providing liquidity to our asset-backed commercial paper program. In addition, it is important that the FDIC approve Ford Credit's industrial loan bank application as another way for us to be able to offer automobile financing to credit-strapped consumers. First filed in June 2006 and refiled in February after an 18-month FDIC-imposed moratorium, Ford Credit's application for an industrial loan bank is still pending further review by the FDIC. We believe that the application and business plan meet the statutory requirements for approval in every material respect. During this extended period, Ford Credit has operated and will continue to operate at a significant competitive funding disadvantage to its competitors. Both domestic (GMAC) and foreign competitors (Toyota and BMW) benefit from FDIC-insured industrial banks and access to stable, low cost FDIC-insured deposits.Financial Results and Economic Climate The bottom line of all of our efforts is that we are now competitive with the best in the world--and it has shown in our financial results. In each quarter of 2007, we delivered year-over-year improvements, excluding special items, and on the same basis posted a $100 million profit globally in the first quarter of this year. We appeared to be well on our way to returning to sustainable profitability next year. As this year has progressed, however, our companies, dealers, suppliers and customers have faced an unprecedented economic crisis and a severe credit crunch. I know that the Committee is all too familiar with the circumstances of our economy, but just a few statistics put the situation we face in sharp focus. While the domestic auto industry has made mistakes in the past, the current problems have been exacerbated by one of the worst economies in nearly three decades. The mix of the housing crisis, credit crunch, wildly fluctuating gas prices and major spikes in commodity prices has lead to an unprecedented reversal in the business environment that is driving not just the U.S. but markets around the world into a synchronized economic downturn. Spending by consumers fell at an annual rate of more than 3 percent in the third quarter (as compared to the second quarter). According to the early November 2008 reading of consumer confidence from the University of Michigan Survey of Consumers, this is the first time in the 50-year history of that survey that consumers were unanimous in their view that the economy is in recession. Consumers' assessment of their economic and financial conditions is the worst since the early 1980s, when the U.S. economy encountered two consecutive recessions. The unemployment rate of 6.5 percent is well above the low point of 4.4 percent in March 2007 and likely will rise significantly in coming months. Job losses are over 1.1 million in the first 10 months of this year, and further reductions in employment are expected. The auto sector is highly reliant on well-functioning credit markets--from manufacturers and suppliers to dealers and consumers. Our industry is one of the first to suffer from bad economic conditions--indeed, spending on new vehicles historically represents about 4 percent of GDP and therefore will predictably be closely tied to those conditions. The early evidence of weak economic growth began to set in during the first half of this year, with consumers facing a weaker job market at the same time that rising food and energy prices were taking up an increasing share of their disposable incomes. As the financial crisis persisted, both credit availability and consumers' weakened confidence contributed to a drastic decline in vehicle sales. There has been a broad-based tightening of origination and underwriting standards for automotive financing, spreading beyond the sub-prime arena to affect many prime borrowers as well. The Federal Reserve Senior Loan Officers' survey shows that banks' willingness to extend consumer installment loans has only been weaker at one time in the past 30 years, and that was in June of 1980. More than 60 percent of banks have tightened standards for consumer credit in the most recent survey. During the last 6 months, light vehicle sales fell at a 45 percent annualized rate, the worst slide since mid-1980. In October, the annualized sales rate for the U.S. industry was only 10.5 million units--compared to over 16 million units just last year. This means the industry has lost over 5 million vehicle sales--the equivalent of two companies the size of Ford in North America--in a single year. October was the worst auto sales month the U.S. industry has seen in 25 years, and we expect it will not be the weakest result we see over this economic cycle. Total industry volumes in 2009 are expected to be weaker than in 2008 on a full-year basis, with significant pressure in the first half of next year. This is not just a case of the domestic auto industry failing to anticipate changing economic conditions. Very few in any industry, of course, predicted the kind of economic headwinds we face today. Certainly our foreign competitors have not been immune from the downdraft. Toyota, Honda, and Nissan each reported a decline in sales of more than 23 percent in October. Importantly for Ford, we have held or slightly increased our market share in the midst of this declining market. But importantly, despite our best efforts, our industry's ability to weather this storm has been directly affected by the external financing environment. The decline in the overall market has been the result of two problems--economic uncertainty that discourages Americans from making major purchases, and a lack of available credit so even some people who want to buy a car are unable to secure credit. This unprecedented pressure on our industry, which is the result of a financial crisis that was not of our industry's making, is coming just at the time when our efforts to restructure Ford have finally begun to bear fruit. The real challenge for this Nation is to find a way to allow our successful restructuring efforts to continue despite these challenging times. To do otherwise would be a disservice to the millions of employees at our plants, suppliers, dealers, and customers who are depending upon our success as well as to the American public. As quickly as these changes have been occurring, of course, we at Ford have been taking fast and decisive action to deal with them. We reduced our production levels dramatically in the face of a shrinking industry demand. In the third quarter alone, we reduced North American production by 219,000 units from the 637,000 vehicles we produced in the third quarter of 2007. Our fourth quarter plans call for production decreases in excess of 210,000 units from the fourth quarter of last year, leaving the company with a full year reduction of over 600,000 units in 2008. We are firmly committed to managing production carefully rather than simply producing units we know the market cannot absorb. We have announced plans to further reduce employment and cut benefits and compensation at all levels. We have eliminated merit raises and bonuses in 2009, and we continue not to pay any dividends to our shareholders. Even as we take these steps, however, we continue to protect our investment in the fuel-efficient new vehicles that we believe will secure our future. Operating under our ``One Ford'' principle, we intend to deliver more vehicles worldwide from fewer core platforms, further reduce costs and allow for the increased use of common parts and systems. The result will be a lineup of highly acclaimed, smaller vehicles in global segments (sub-compact, compact, and mid-size vehicles, and commercial vans) beginning in mid-2009. About 40 percent of Ford's entries in these segments will be shared between Ford North America, Ford Europe, and Ford Asia Pacific by 2010, with 100 percent alignment achieved by 2013. And, as I mentioned earlier, we are committed to deliver every new product with the best or among the best fuel economy in its segment, driven by the most extensive powertrain upgrades ever for Ford.The Bridge to Transformation What I have outlined so far is the dramatic transformation taking place at Ford and the intense economic headwinds we now face as we attempt to continue and complete that transformation. The question remains whether we as a company and collectively as an industry will have time given the unprecedented short-term economic conditions to complete our transformation for the long term. Speaking only for Ford, we are hopeful that we have enough liquidity based on current planning assumptions and planned cash improvement actions, but we also know that we live in tumultuous economic times in which rapid and unexpected change seems to be the norm rather than the exception. While we are cautiously confident, we must also be prudent, and prudence at this point requires that we prepare ourselves for the prospect of deteriorating economic conditions in 2009. We also know that at least one of our competitors has reported that, absent the ability to secure additional funding, its estimated liquidity will fall significantly short of the minimum required to operate its business in the first two quarters of next year unless conditions rapidly improve--which we don't expect. If any one of the domestic companies should fail, we believe there is a strong chance that the entire industry would face severe disruption. Ours is in some significant ways an industry that is uniquely interdependent--particularly with respect to our supply base, with more than 90 percent commonality among our suppliers. Should one of the other domestic companies declare bankruptcy, the effect on Ford's production operations would be felt within days--if not hours. Suppliers could not get financing and would stop shipments to customers. Without parts for the just-in-time inventory system, Ford plants would not be able to produce vehicles. Our dealer networks also have substantial overlap. Approximately 400 of our dealers also have a GM or Chrysler franchise at their dealership, and we estimate that as many as 25 percent of our top 1,500 dealers also own GM or Chrysler franchises. The failure of one of the companies would clearly have a great impact on our dealers with exposure to that company. In short, a collapse of one of our competitors here would have a ripple effect across all auto makers, suppliers, and dealers--a loss of nearly 3 million jobs in the first year, according to an estimate by the Center for Automotive Research. In the face of incredibly fragile economic conditions and the interdependence of our industry, we believe it is appropriate at this time to join our competitors in asking for your support to protect against an uncertain economic future that threatens all of the progress we have made to accomplish a goal that serves the interests of this Nation--creating a strong and viable American automotive industry. I know we can achieve this goal because we at Ford are implementing the transformational changes that are required to achieve it--as long as we can survive the present economic turmoil. Our request today is to gain access to an industry bridge loan that would provide all of us with an available tool to navigate through this difficult economic and financial crisis. We would suggest that the loans be structured in a revolving format so that the exposure to the taxpayer would be limited--and, if used, we would repay with interest.The Public Interest It should come as no surprise that we who are testifying before you today believe the domestic automotive industry should be supported and preserved as it transforms to meet the new challenges of meeting changing consumer demands and environmental imperatives in a difficult economic environment. The question before you, however, is one of the public interest--is the public interest better served by offering aid to the industry at this time or by letting market and regulatory forces work to whatever future they might bring? I respectfully submit that the public interest is clear--this industry merits your support. I have already detailed at length the ways in which our iconic American Ford Motor Company is transforming itself for the future, and I know my colleagues from General Motors and Chrysler are equally confident of presenting a compelling vision of the future. We all believe that future is worth supporting. But perhaps the most compelling reason for you to support our industry comes upon consideration of the consequences that would be visited on our already fragile economy if this industry should collapse. At the end of 2007, Chrysler, Ford, and General Motors directly employed about 240,000 American workers and indirectly supported more than 4.5 million other workers in the U.S. The Detroit Three are among the Nation's largest purchasers of U.S.-manufactured steel, aluminum, iron, copper, plastics, rubber, electronics, and computer chips. Last year, they provided health care to nearly 2 million Americans and paid pension benefits to 775,000 retirees or their survivors. One recent study estimated that in the event the Detroit Three were to cease operations in 2009, employment loss would be nearly 3.0 million jobs, personal income would be reduced by over $150 billion, and the loss to the government in tax revenue would be more than $60 billion--in the first year alone. Even a 50 percent reduction in our operations would result in devastating losses to the economy, according to this study. Many more statistics are available. Each would demonstrate that the collapse of the U.S. automotive industry would be a calamity for the entire economy. This is not a claim that any individual company is ``too big to fail,'' although of course that sort of claim seems to have been at work in some recent--and far more costly--actions taken in other sectors in response to the economic crisis. Rather, ours is a claim that a large swath of the industry rises and falls together, and that the industry collectively is too big and too important to fail. The linkages we have through our suppliers, dealers, workers and customers mean that there are very few isolated events in our industry. I would therefore urge you as you consider our request not to think of individual companies but rather of the industry--and the economy--as a whole. Of course, more than mere economics are at play. It would not be overstating the case to observe that our Nation's ability to engage in heavy manufacturing is very much at stake and is a matter of national security. No less an authority than former NATO Commander General Wesley Clark eloquently made that point in a column in last Sunday's New York Times that I commend to the Committee: More challenges lie ahead for our military, and to meet them we need a strong industrial base. For years the military has sought better sources of electric power in its vehicles-- necessary to allow troops to monitor their radios with diesel engines off, to support increasingly high-powered communications technology, and eventually to support electric propulsion and innovative armaments like directed-energy weapons. In sum, this greater use of electricity will increase combat power while reducing our footprint. Much research and development spending has gone into these programs over the years, but nothing on the manufacturing scale we really need. Now, though, as Detroit moves to plug-in hybrids and electric- drive technology, the scale problem can be remedied. Auto makers are developing innovative electric motors, many with permanent magnet technology, that will have immediate military use. And only the auto industry, with its vast purchasing power, is able to establish a domestic advanced battery industry. Likewise, domestic fuel cell production--which will undoubtedly have many critical military applications--depends on a vibrant car industry. Our industry is proud of the role we have played through the years in meeting our national security needs, and we believe that role will continue to be critical in the years to come.Conclusion We live in difficult and challenging times, and have discovered in recent weeks and months that both old solutions and new must be re-examined and adjusted to meet rapidly changing conditions. At Ford Motor Company, we remain committed to constant examination and response as we face new challenges. With each of those challenges, however, I become more convinced than ever that we have the right plan to transform Ford and that our best days are ahead of us. The reality is that Ford already is well on our way to realizing a complete transformation of our company--building a new Ford that has a very bright future. With your help, we will together ensure that bright future for Ford and the entire American auto industry. With your help, we will create a safeguard to deal with the current unprecedented economic uncertainty, while all of us at Ford continue to deliver on our plan. And, as we continue to be an important part of communities across America, we look forward to working with you to be part of the solution on the road to economic recovery. Thank you. ______ CHRG-111hhrg67816--41 Mr. Green," Mr. Chairman, thank you for your friendship over the last 17 years. I thank you for holding this hearing on the consumer credit and debt protection and to look at the role that the FTC should play. I would like to welcome our new FTC chairman, Jon Leibowitz, and congratulate him on the new position as the chair of the Commission. I look forward to working with you. The FTC is important all the time but in this day and time it is even more so. As the primary federal agency that enforces consumer credit laws at entities other than banks, the thrifts and federal credit unions, the FTC has broad responsibility regarding consumer financial issues in the mortgage market including those involving mortgage lenders, brokers, and services. The FTC enforces a number of federal laws governing mortgage lending, Truth in Lending Act, the Home Ownership and Equity Protection Act, and the Equal Credit Opportunity Act. The Commission also enforces Section 5 of the Federal Trade Commission Act which more generally prohibits unfair and deceptive acts or practices in the marketplace. That is probably one of the most important that we can deal with. In addition, the Commission enforces a number of other consumer protection statutes that govern financial services including Consumer Leasing Act, Fair Debt Collection Practice Act, the Fair Credit Reporting Act, the Credit Repair Organization Act, and the privacy provisions of the Gramm-Leach-Bliley Act. I also have a particular concern about non-traditional loans such as pay-day loans and car title loans, which can carry enormous interest rates and fees. In 2006, Congress enacted to cap the pay-day loans made to military personnel to a 36 percent annual percentage rate after pay-day loans grew 34 percent to reach a total of 500 million the previous 2 years. That figures has doubled since 2002. In an economic climate such as the one we are in today where credit availability is shrinking consumers may be more inclined to turn to these options which are much less regulated and therefore the potential for predatory practice is much greater. In recent months, the FTC has taken significant steps to protect consumers and crack down on scam artists by going after Internet pay-day lenders, alleged mortgage foreclosure rescue companies, and companies claiming they remove negative information from the consumers' credit reports. I look forward to hearing what other actions the FTC is making to protect consumers, what tools it may need from Congress, and what the rest of our witnesses believe could be done better to protect consumers in today's volatile economic environment. All told, this gives the FTC broad authority to go after those predatory practices. The Congress may need to act particularly to give FTC authority to issue rules under the Administrative Procedures Act. Again, Mr. Chairman, thank you for calling the hearing, and I appreciate the opportunity. " CHRG-110hhrg44901--57 Mr. Bernanke," Well, first of all, IndyMac did fail, and the Fed did not do anything about that. I would add to your constituents, as I mentioned earlier, that all insured deposits were available immediately and no insured depositor is going to take any loss from that. We have in this episode just been confronted with weaknesses and problems in the financial system that we didn't fully--we collectively, the regulators, the Congress, the economists did not fully anticipate. And in the interest of the broader financial system and particularly as always, always the ultimate objective is the strength of the economy and the conditions for--economic conditions for all Americans. We found weaknesses and we had to respond in crisis situations. I think that--while I certainly would defend the actions we have taken, I would much prefer in the future not to have to take such ad hoc actions and, as I described, I think to Ranking Member Bachus, the best solution is to have a set of rules that govern when a bank can be or other institution can be, you know, put through a special process. In particular, we already have such a process for depository institutions, which is a fiduciary process where the requirement is that the government resolve that bank at the least cost to the taxpayer unless a determination by a broad range of financial officials that a systemic risk exists, in which case other measures could be taken. So I think it wouldn't be appropriate for me to try to give you any guidelines right now. I think what we are doing right now is trying to do the best we can to make sure the financial markets continue to improve, and that they begin to function at a level which would be supportive of the economy. I think what is critical is as we go forward, we take stock from the lessons we have learned from this experience and try to set up a system that will be less prone to these kinds of difficult decisions that we have had to make. " FOMC20070918meeting--258 256,MR. MADIGAN.," Well, partly by auctioning credit, so institutions are coming to the Federal Reserve voluntarily and paying a price that is market based. Another point is that the institutions are regarded as generally sound. They have to meet a certain qualification standard to get to the discount window, and we would be taking certain steps in terms of our reports to try to distinguish this from other discount window credit. Now, that said, I think we have to admit that we’re not sure the degree to which this would deal with the stigma issue." CHRG-111hhrg55811--310 Mr. Hixson," For us, we have estimated it would cost approximately about a billion dollars depending upon market conditions, an additional amount of money we would have to borrow. For some local context, one of our largest investments--we have two members from Kansas City sitting here. We built a brand new oil facility, our largest in the United States, in Kansas City. So for us we would have to choose whether you put that money in margin or do you continue and build that plant. That is the type of thing we have to decide. " FOMC20050322meeting--168 166,MR. SANTOMERO.," The only thing that concerns me about the sentence we’ve been working on is this: I’m not sure it actually does anything good. Where we were, to my mind, may be better than where we’re going. I’m not sure what “should” means in the context, and I’m not sure the conditioning actually moves us ahead. We may be better off staying with the wording in the February statement, which is ambiguous as to policy action and doesn’t talk about normative statements like “should.” That has the benefit of not moving us in the wrong direction, so we can address where we want to be in May." fcic_final_report_full--388 AIG: “WE NEEDED TO STOP THE SUCKING CHEST WOUND IN THIS PATIENT ” AIG would be the first TARP recipient that was not part of the Capital Purchase Pro- gram. It still had two big holes to fill, despite the  billion loan from the New York Fed. Its securities-lending business was underwater despite payments in September and October of  billion that the Fed loan had enabled; and it still needed  bil- lion to pay credit default swap (CDS) counterparties, despite earlier payments of  billion. On November , the government announced that it was restructuring the New York Fed loan and, in the process, Treasury would purchase  billion in AIG pre- ferred stock. As was done in the Capital Purchase Program, in return for the equity provided, Treasury received stock warrants from AIG and imposed restrictions on dividends and executive compensation. That day, the New York Fed created two off-balance-sheet entities to hold AIG’s bad assets associated with securities lending (Maiden Lane II) and CDS (Maiden Lane III). Over the next month, the New York Fed loaned Maiden Lane II . bil- lion so that it could purchase mortgage-backed securities from AIG’s life insurance company subsidiaries. This enabled those subsidiaries to pay back their securities- lending counterparties, bringing to . billion the total payments AIG would make with government help. These payments are listed in figure ..  Maiden Lane III was created with a . billion loan from the New York Fed and an AIG investment of  billion, supported by the Treasury investment. That money went to buy CDOs from  of AIG Financial Products’ CDS counterparties. The CDOs had a face value of . billion, which AIG Financial Products had guaran- teed through its CDS.  Because AIG had already posted  billion in collateral to its counterparties, Maiden Lane III paid . billion to those counterparties, provid- ing them with the full face amount of the CDOs in return for the cancellation of their rights under the CDS.  A condition of this transaction was that AIG waive its legal claims against those counterparties. These payments are listed in figure .. Goldman Sachs received  billion in payments from Maiden Lane III related to the CDS it had purchased from AIG. During the FCIC’s January , , hearing, Goldman CEO Lloyd Blankfein testified that Goldman Sachs would not have lost any money if AIG had failed, because his firm had purchased credit protection to cover the difference between the amount of collateral it demanded from AIG and the amount of collateral paid by AIG.  Documents submitted to the FCIC by Goldman after the hearing do show that the firm owned . billion of credit protection in the form of CDS on AIG, although much of that protection came from financially unsta- ble companies, including Citibank (. million), which itself had to be propped up by the government, and Lehman (. million), which was bankrupt by the CHRG-110shrg50410--39 Chairman Dodd," Thank you very much. Senator Bennett. Senator Bennett. Thank you very much, Mr. Chairman. Mr. Secretary, going to your testimony on the second page, you say, ``Let me stress that there are no immediate plans to access either the proposed liquidity or the proposed capital backstop.'' And you have made that very clear, and I think appropriately so. Then this sentence: ``If either of these authorities is used, it would be done so only at Treasury's discretion, under terms and conditions that protect the U.S. taxpayer and are agreed to by both Treasury and the GSE.'' Can you help us understand a little bit more the specifics of the terms you have agreed to with the GSE? Or are there any---- " CHRG-111shrg49488--104 Mr. Clark," Maybe I should just mention one other feature that I have not underscored but we found a tremendous difference on the two sides of the border. In Canada, because we hold all the mortgages, modifying the mortgages is easy to do. We do not have to ask anyone's permission to modify the mortgage. And it is not the government coming to us and saying, ``Would you start? Here is our modification program.'' We just were instantly modifying the mortgages. Last year, we represented about 20 percent of the mortgage market in Canada. We only foreclosed on 1,000 homes in a whole year, to give you an order of magnitude. And every one of those thousand we regarded as a failure. And so the last thing we would ever want to do is actually foreclose on a good customer. And so we go out of our way to modify the mortgages, and that is just natural practice for us because I do not have to ask permission of some investor whether or not I want to do this or can do it or what rules are governing it. So I do think that has turned out in this crisis to be a second feature that, frankly, none of us would have thought about until the current crisis. In terms of our specifics, we are required, if we, in fact, lend more than 80 percent loan-to-value, to actually insure the mortgage so that represents a constraint. It would not have represented a constraint to the kind of no documentation lending that was done in the United States because the actual underwriting we are doing. But then again, because we actually would be holding the mortgages, we insisted on full documentation. There is not interest deductibility. I think there is no question that the feature of having interest deductibility in the United States is a major factor for leveraging up. And despite the fact that it is justified on the basis that it encourages homeownership, historically homeownership has actually been higher in Canada than it has been in the United States. So there is no evidence that the two are linked at all. All it does is inflate housing prices because, in fact, people look at the after-tax cost in computing the value on which they are to bid for the houses. So I would say those are the main features. We do have mortgage brokers, but they are originating mortgages which we then hold. We do not sell them on. And I think that is the core feature. Senator Collins. And just to clarify, in most cases the homebuyer is putting down 20 percent. Is that correct? " CHRG-111hhrg58044--128 Chairman Gutierrez," The time of the gentleman has expired. Mr. Moore is recognized for 5 minutes. Mr. Moore of Kansas. Thank you, Mr. Chairman. Our Oversight and Investigations Subcommittee held the first in a series of hearings last week on the topic of the end of excess, a broad look at lessons learned from the crisis. I believe that one lesson from the financial crisis is we need to go back to living within our means and that is true for our government, for financial firms, for businesses, families, and individuals. Mr. Snyder, I agree with the point you make in your testimony that we need to increase financial literacy, which will be the focus of one of our subcommittee hearings in our lessons learned series. We need to teach personal finance to our students in high school and college, ensuring that our young people are fully empowered to make sound financial decisions. Mr. Snyder, as we think about credit scores, how can we encourage individuals to regularly review their credit report, correct any misinformation, and learn how to build their credit scores? " FOMC20071031meeting--205 203,CHAIRMAN BERNANKE.," Thank you. Thank you all. Well, it has been said many times, but this is very, very close, and I’ve thought about it quite a bit, obviously. I have a lot of sympathy for President Plosser’s very clear analysis. There have been good data since the last meeting. We have talked about the importance of spillovers. We have not so far seen evident spillovers from housing into other sectors. We did take a preemptive action in the last meeting. Inflation is a concern. I think not immediately, but some of the factors like input costs are there, and market expectations alone are obviously not a reason to move. All of those things are valid, and I have thought about all of them. So why do I favor a cut? Most of the arguments have been made. The downside risks are quite significant, if the housing situation, including prices, really deteriorates. I think part of the difference between what the market sees about housing and what we see is that we are a little more sanguine about price behavior than the market is, and a decline in prices has effects both on consumers and on the credit system. So I think that risk is fairly important and may swamp some of the other issues. There is some new information that is relevant. The senior loan officer survey and other information suggest that credit conditions are tightening and that this will have an effect, I believe, in some significant markets, certainly including housing. Other information, like consumer sentiment and consumers’ views of the labor market, suggests some slowing and some weakening. The decline in sentiment in the markets in the past two weeks is very interesting. On one level I feel as though we failed to communicate somehow; however, I don’t know exactly where the mistake was. The markets seem to be responding to information about earnings reports and projections of future activity and so on, both in the financial sector and in the real sector, and as a number of people have said, I don’t think we can entirely ignore that information. So I think there are some good reasons on the real side to take out a bit more insurance, as has been said. I agree with the Vice Chairman that the credit markets probably could stand the surprise, but they have become somewhat more uncertain, and I think their basic problem is macro uncertainty. It has to do with concerns about tail risk, and that is something that we can, I think, address a bit. The point has been made a number of times, first by President Yellen, that the current rate could be construed as being slightly restrictive and that creates an argument for a somewhat lower rate. An additional argument is that the core inflation rate has come down some since last year, and so the real federal funds rate on that basis has gone up. Finally, an argument that I would bring to you is about tactics, and the Vice Chairman also alluded to this. Most of the paths that we submitted include a path for policy that is perhaps slightly lower than the current one, and the question is how we do this. If we take alternative B, which I think is the most obvious alternative, on the one hand we don’t take an action and on the other hand we express alarm about the economy and say we’ll probably be cutting in the future. That makes calibrating how the longer-term expectations will respond to that very difficult. I think it would, on balance, tighten expectations a bit because we didn’t act, but it does create some uncertainty. The advantage of alternative A, even as we take a cut, is that we will, I hope, curb expectations for sustained additional cuts through several mechanisms. First, in the economic growth paragraph, we have switched language from actions “intended to help forestall”—very indirect—to “should help forestall,” suggesting that we are now more confident in our ability to prevent bad outcomes in the economy. Second, we have—and this will certainly be noticed—taken note of energy and commodity prices, among other factors, and we have highlighted our concerns about inflation. Third, the rough balance of risks certainly indicates that we are not eager to cut again quickly unless the data clearly support it. So a lot of this is tactical, about how to take control of expectations— you know, how to manage the market’s views of our policies. And I just felt a bit more comfortable with taking the action but then using that to recalibrate our balance of risks. For what it is worth, 75 basis points of easing has been pretty much the standard Fed medicine for financial crises ever since 1970 or so; in that respect we are in good company. That’s my recommendation—25 basis points with alternative A. Any questions or comments?" FOMC20080625meeting--302 300,MR. WARSH.," Thank you, Mr. Chairman. Let me make a few prefatory comments, and then try to answer a couple of the key questions in the memo. First, a crisis is a terrible thing to waste. My sense is that we have an opportunity here to do the right thing over the period to try to get market discipline--to Charlie's point--back and vibrant and working countercyclically with regulatory discipline and capital standards. So this is an opportunity. As we contemplate our six-months-and-a-day problem, what do we do between September and year-end? I agree with Vice Chairman Geithner's comment that we need to keep options open, and I will make a proposal in a moment for how to do that. Second, the memo from the staff said that improvements in financial markets have resulted, importantly, from the availability of the special liquidity facilities, and I agree with that. But I wouldn't give short shrift to the other things that have been going on in the markets that have improved market functioning. I don't think it is fair to say that we deserve a disproportionate amount of credit for what has happened. We have seen a ton of capital-raising. We have seen a lot of diversification of funding sources. We have seen changes in duration by financial institutions. We have seen improved disclosure and transparency. We have seen big write-downs. We have seen brutal changes in management teams. We have seen pairing of business lines and improved risk management. So it strikes me that market discipline is alive and well. It was necessary for us to do what we did, but I think it hangs way too much on our facilities if we suggest that we are the only thing that is keeping the system together. As a final prefatory comment, the memo says that some investors have indicated their willingness to lend to primary dealers in recent months, and that has been conditioned on dealers' access to the PDCF. It strikes me that proves too much. I am not sure that is a good thing. The concerns we have late in the cycle, when we look back, include that market discipline broke down. In the short term, obviously, we want to see some of the money market mutual funds from President Rosengren's neck of the woods hang in there with these institutions so we don't have a sort of panic coming. But over the short to medium term, we want the guys in money market mutual funds to recognize that, when they are providing funding overnight, they are making an investment decision that has a risk. So I hesitate to suggest that we want to do things over the period that let them be complacent. We want to do things that make them very focused on the decisions they are making. Now a bit to the key questions that were asked in the memo. First, on liquidity facilities, on the question of the PDCF and its symmetry with the TSLF, I like that notion of the balance of having an auction and having one that is available more regularly. But we have to recognize that the PDCF, whether intended or not, has been stigmatized. If Lehman Brothers, when they were on their darkest day, had answered the question differently, I dare say they might not be in existence. They were asked, ""Have you accessed the PDCF?"" The answer was, ""Absolutely not."" If their answer to that had been ""yes,"" I suspect that they and we could have been in a very different circumstance. So what does that prove? I think that proves that the existence of these facilities matters. It keeps institutions in the game. The particular terms matter less. But also, in extremis, accessing that facility, unlike the securities lending facility, causes losing a considerable amount of control over one's own fate. So I think we have to take that into consideration. We have considerable leverage over these institutions at this time. No matter what they and their lobbyists say, they want us to be their regulator more than they can possibly contain themselves--mostly for our credibility and mostly for our balance sheet. I worry that if we extend the PDCF as is by just punting it down the road some months, we will lose some of that leverage. So one idea, which I must say I haven't explored as much as I probably should, is extending the PDCF, not as is but by modifying it in a way that would make Bagehot proud--by making it more expensive, by widening the spread. Now, there are other things we could do in this short-term extension that modify its terms--changing collateral or changing haircuts. But it strikes me that price might be an interesting way to say, ""Listen, we aren't pre-judging outcomes, but you can see from this move that we aren't comfortable with the status quo, and we are asking ourselves these very hard questions that we brought to bear."" That could send an important signal, which I don't think would be overly disruptive to the markets if we explained some of the rationale for doing it. Let me turn, finally, to the prudential supervision questions. I have a note here in answer to the first question, ""How do we limit moral hazard if we continue the facilities?"" My bold answer is ""carefully,"" so I guess not much is there. On what principles should supervisory expectations be based? I think Art talked rightly about these different regulatory frameworks for the big money center commercial banks and the investment banks. We'd be doing ourselves a disservice over the period, Mr. Chairman, to take the regulatory regime that we have now had for a long time for these big complex commercial banks and try to put it on the investment banks. I'll answer this the way I began. We have an opportunity to start with a blank sheet of paper, with four institutions over the period, and figure out how to be really, really good regulators, building on the lessons that we have learned from our traditional supervision and regulation function. I think that we would be making a mistake by saying, ""We have a model, and let's throw it on these guys."" If we regulate these four institutions the way we have long been regulating commercial banks with the OCC and others, I think we won't have maximized the best of regulation. The goal would be to figure out how to regulate these four right and then, frankly, to export those lessons to what we have long been doing to make regulation better and stronger across this group. If it turns out that we do to Goldman Sachs and Morgan Stanley what we have been doing to Citi and JPMorgan, as was suggested, we will find other people will be in the business of investment banking, so we won't have done terribly much to mitigate systemic risk. Finally, on the question about the role for the Congress. Both in the medium term, Mr. Chairman, in the context of your speeches and as we get toward the end of July, when you announce some modification--if the FOMC agrees--about these facilities and the PDCF, it is very important that the Congress be given serious responsibility for this. It has been very easy for them to criticize, on the one hand, and to whisper to us all their support, on the other. I think they need to be given very important homework assignments in terms of what they can do. Some form of FDICIA with investment banks might be one example. Wrestling about these issues in terms of regulatory organizations strikes me as very consequential. Even if we could convince ourselves that we have all the regulatory authority to figure this out with our regulators, we would be better off, when we are ready and we have the right answer in our own view, to bring it to the Congress for final clarity and to get their imprimatur. Thank you, Mr. Chairman. " CHRG-111hhrg51698--550 Mr. Fewer," Thank you, Mr. Chairman. Chairman Peterson, Ranking Member Lucas and Members of the Committee, my name is Donald Fewer, Senior Managing Director of the Standard Credit Group, LLC in New York. As the first inter-dealer broker in the over-the-counter CDS market, I consummated the first trades between dealers at the market's inception in 1996, and have participated in the market's growth and development since then, including single named CDS, credit index and index tranches. I have submitted my full statement for the record and will comment on four areas in the proposed legislation. The first is regarding central counterparty clearing. My first point is an affirmation of the sentiments expressed by virtually all of the panelists that central clearing facilities of organized exchanges will work to eliminate counterparty credit issues in over-the-counter bilateral derivative contracts, and will undergird and strengthen the over-the-counter derivatives market infrastructure. Providing access to all market participants, sell-side and buy-side, to an open platform centered in CCP, will stimulate credit market liquidity by reconnecting more channels of capital to the credit intermediation and distribution function. The use of exchange CCP facilities will have a significant impact on credit markets by enabling participants to free up posted collateral and recycled trading capital back into market liquidity. Legislation that expands the role of organized exchanges beyond CCP to include exchange execution of OTC credit derivative products will be disruptive, and lacks the clear recognition of the already well-established and economically viable over-the-counter market principles. My second point is exchange execution of over-the-counter credit derivative products. Given the size and established structure of the OTC derivatives market, migration toward exchange execution has been, and will be, minimal apart from mandatory legislative action. It has been argued that the lack of standard product specifications of OTC derivatives is a market flaw and should be remedied by mandated exchange listing and execution. This argument lacks support. CDS contracts utilize standard payments and maturity dates. Credit derivative participants have adopted a higher degree of standardization because credit risk is different from the other types of underlying risks. Unlike interest rate swaps in which the various risks of a customized transaction can be isolated and offset in underlying money and currency markets, credit default swaps involve lumpy credit risks that do not lend themselves to decomposition. Standardization, the most significant attribute of exchange-traded products, is therefore a substitute for decomposition. Recent improvements in CDS market standards have resulted in up-front payments, and the establishment of annual payments that resemble fixed coupons similar to bonds. These changes will simplify trading and reduce large gaps between cash flows that can amplify losses. Most importantly, enhancing these standards will build a higher degree of integration between CDS and the underlying over-the-counter cash debt markets that simply cannot be replicated on an exchange. This aggregation and dispersion of credit risk between the over-the-counter cash and derivative markets is critical to the development of overall debt market liquidity, going forward. Other mechanisms implemented by the OTC market include post-default recovery rate auction and trade settlement protocols, innovation and portfolio compression methodologies. All of these functions performed exceptionally well during the market turbulence of last year. A regulation that would force exchange execution of CDS products would be harmful and disruptive to the credit risk transfer market. The third point I would like to address is underlying bond ownership requirements as proposed by the legislation. The draft legislation fails to recognize the underlying risk transfer facility of the plain vanilla credit default swap by requiring bond ownership. Limiting CDS trading to underlying asset ownership will cripple credit markets by stripping from the instrument the risk management and credit risk transfer efficiencies inherent in its design. The basic use of a credit default swap enables a credit intermediary, such as a commercial bank, to trade and transfer credit risk concentrations while being protected from a default at the senior unsecured level of the reference entity's capital structure. For example, financial institutions servicing large corporate clients must offer commercial lending, corporate bond underwriting, working capital facilities and interest rate risk management. In addition, the financial institution provides a market-making facility in all of the secondary markets for which it underwrites a client's credit. All of these financial services expose the financial institution to client counterparty risk. The credit risk transfer market optimizes the use of capital by enabling financial intermediaries to efficiently hedge and manage on- and off-balance-sheet credit risk. Credit derivatives therefore play a vital role to credit intermediation and market liquidity. Requiring bond ownership will counteract and work directly against the credit stimulation initiatives in the economic stimulus legislation currently under consideration. My fourth and final point is the unintended consequences of inappropriate regulatory action. As I detailed in my full statement, the value of cash bond trading has declined dramatically since the implementation of FINRA's Trade Reporting and Compliance Engine known as TRACE. TRACE led directly to the deterioration of the over-the-counter inter-dealer, investment-grade, and high-yield bond trading volume. While TRACE was anticipated to facilitate transparency, its implementation revealed the failure to fully understand over-the-counter corporate bond market structure, and created an inadvertent level of disclosure that frankly devastated the economic basis for dealer market-making. The lack of a liquid secondary market for corporate debt throughout the term structure of credit spreads dramatically increased the risk in underwriting new debt. The underwriters and dealers facility to trade out of and manage bond risk was so restricted that the unintended consequence was to damage the secondary bond market. It is not coincidental that the U.S. high-yield bond market reported zero new-deal issuance for the month of November in 2008. Almost half of the U.S. companies fell below investment-grade credit ratings, making the $750 billion high-yield bond market a critical source of financing. Mr. Chairman, Mr. Ranking Member and Members, I appreciate the opportunity to provide the testimony today and would urge you to continue to reach out to the inter-dealer market for its input. [The prepared statement of Mr. Fewer follows:] Prepared Statement of Donald P. Fewer, Senior Managing Director, Standard Credit Group, LLC, New York, NY Mr. Chairman Peterson, Ranking Member Lucas and Members of the Committee: Good morning. My name is Donald P. Fewer, Senior Managing Director of Standard Credit Group, LLC. a registered broker/dealer and leading provider of execution and analytical services to the global over-the-counter inter-dealer market for credit cash and derivative products. I was fortunate enough to have consummated the first trades between dealers at the markets inception in 1996 and have participated in the market's precipitous growth and development as well as its challenges. I would like to thank this Committee for the opportunity to share my thoughts on the draft legislation on Derivatives Markets Transparency and Accountability Act 2009, as it applies to the over-the-counter market generally and the credit derivatives market specifically. The Committee's draft legislation comes at a pivotal time. The consequences of the crisis paralyzing global credit markets will have significant and long term effects on credit creation, intermediation and risk transfer. I believe that legislation that attempts to address derivative market accountability and transparency should reflect a clear understanding of credit market dynamics, particularly credit risk transfer. With this in mind, I would like to address five areas of the draft legislation that does not meet this pre-requisite: Central Counterparty Clearing and the Role of Organized Exchanges. Exchange Execution of OTC Credit Derivative Products. Transparency and Price Discovery. Underlying Bond Ownership Requirements of CDS. Unintended Consequences of Inappropriate Regulatory Action.Central Counterparty Clearing, Credit Risk Transfer Derivatives and the Role of Organized Exchanges There has been significant criticism of the over-the-counter derivative products market, particularly credit derivatives, as the root cause of our global crisis. While much disparagement is based upon misinformation and misunderstanding, effective regulation directed at supporting the proper functioning of the credit risk transfer market is critical. Use of central clearing facilities of organized exchanges will not only work to eliminate counterparty credit issues in OTC bilateral derivative contracts, it will undergird and strengthen the OTC derivatives market infrastructure. The role of organized exchanges, in providing CCP services, can be the mechanism by which new capital and liquidity providers participate in the credit risk transfer market. The use of CCPs by all market participants, including ``end-users'' (i.e., hedge funds, asset managers, private equity groups, insurance companies, etc.) should be encouraged by providing open and fair access to key infrastructure components including but not limited to exchange clearing facilities, private broker trading venues and contract repositories. OTC trading venues will provide voice and electronic pre-trade transparency, trade execution and post-trade automation. This view of providing access to all market participants, sell side and buy side, to an open platform centered in CCP, will stimulate credit market liquidity by re-connecting more channels of capital to the credit intermediation and distribution function. The use of exchange CCP facilities will have a significant effect by enabling participants to free up posted collateral and recycle trading capital back into market liquidity. However, the proposed legislation, which expands the role of organized exchanges beyond CCP to include exchange execution of OTC credit derivative products, will be disruptive and lacks a clear recognition of the already well established and economically viable OTC market principles.Exchange Execution of OTC Credit Derivative Products: Disruptive and Unnecessary Given the size and establishment of the OTC derivatives market, migration toward exchange execution has been and will be minimal apart from mandatory legislative action. With regard to CDS, the failure to migrate to exchange execution is because the credit derivatives market is characterized with a higher degree of standardization than other forms of OTC derivatives. It has been argued that the lack of standard product specifications of OTC derivatives is a market flaw and should be remedied by mandated exchange listing and execution. This argument is inaccurate. CDS contracts utilize standard payments and maturity dates. Credit derivatives participants have adopted a higher degree of standardization because credit risk is different from other types of underlying risks. Unlike interest rate swaps, in which the various risks of a customized transaction can be isolated and offset in underlying money and currency markets, credit default swaps involve ``lumpy'' credit risks that do not lend themselves to decomposition. Standardization, the most significant attribute of exchange traded products, is therefore a substitute for decomposition. Recent work on reinforcing CDS market standards will result in upfront payments and the establishment of annual payments that will resemble fixed coupons. These changes will simplify trading and reduce large gaps between cash flows that can amplify losses. Most importantly, enhancing these standards will build a higher degree of integration between CDS and underlying OTC ``cash'' debt markets that cannot be replicated on an exchange. This aggregation and dispersion of credit risk between OTC cash and derivative markets will be critical to the development of overall debt market liquidity going forward. Other mechanisms implemented by the OTC market include post-default recovery rate auction and trade settlement protocols, novation and portfolio compression methodologies. All of these functions performed exceptionally well during the market turbulence of last year. A regulation that would force exchange execution of CDS products would be harmful and disruptive to the credit risk transfer market. It has also been argued that the ``opaqueness'' of the OTC derivatives market is a detriment to market transparency and price discovery and exchange listing and execution is required to increase the integrity and fairness of the market place. With respect, this position does not reflect current market realities.Transparency, Execution and Post-Trade Automation: The Work of OTC Markets The over-the-counter market has a well established system of price discovery and pre-trade market transparency that includes markets such as U.S. Treasuries, U.S. Repo, EM sovereign debt, etc. OTC markets have been enhanced by higher utilization of electronic platform execution. Private broker platforms will interface directly to CCPs and provide automated post-trade services. This was clearly demonstrated in the wake of Enron's collapse and the utilization of CCP facilities by the leading over-the-counter energy derivatives brokers to facilitate trading and liquidity. It is clear to all market participants that financial dislocation and illiquidity will persist across many asset classes and geographies for some time. As alluded to earlier, the unique nature of the OTC market's price discovery process is absolutely essential to the development of orderly trade flow and liquidity in fixed income credit markets. We are entering a period with an abundance of mispriced securities where professional market information and execution is required. OTC price discovery throughout the term structure of credit spreads will require a more focused and integrated execution capability between OTC CDS and cash, utilizing key component inputs from equity markets and the various constituents of the capital structure (i.e., senior and subordinated corporate bonds, loans, etc.). This type of exhaustive price discovery service can only be realized in the over-the-counter market via execution platforms that integrate derivatives and cash markets across asset classes (i.e., debt, equities, emerging markets, etc.). This will be critical to the repair of credit market liquidity globally. The implementation of a central trade repository, (i.e., DTCC), that is publicly disseminating detailed information of the size, reference entity and product break-down of the credit derivatives market on a weekly basis will serve to strengthen public confidence in disclosure and transparency of the CDS market.Underlying Bond Ownership Requirements: The Virtual Elimination of the Inherent Value of CDS The draft legislation fails to recognize the underlying risk transfer facility of the ``plain vanilla'' credit default swap by requiring bond ownership for credit default swap purchases. Limiting CDS trading to underlying asset ownership will cripple credit markets by stripping from the instrument the risk management and credit risk transfer efficiencies inherent in its design. The basic use of a credit default swap enables a credit intermediary (i.e., commercial bank) to trade and transfer credit risk concentrations while being protected from an event of default at the senior unsecured level of the reference entities capital structure. For example, a financial institution servicing a large corporate client is required to offer commercial lending, corporate bond underwriting, working capital facilities, interest rate management services, etc. In addition, the financial institution provides a market-making facility in all of the secondary markets for which it underwrites a client's credit (i.e., senior, junior and convertible bonds, loans, etc.) All of these above services expose the financial institution to counterparty risk to the corporate customer. The credit risk transfer market optimizes the use of capital by enabling financial intermediaries to efficiently hedge and manage on and off balance sheet (i.e., unexpected credit line draw-downs, ``pipeline'' risk, etc.) credit risk. Credit derivatives therefore play a critical and vital role to credit intermediation and market liquidity. The implementation of the use of CDS in requiring bond ownership will counteract and work directly against the credit stimulation initiatives currently under consideration by Congress in the Economic Stimulus Bill H.R. 1.Unintended Consequences of Inappropriate Regulatory ActionTRACE--an example of disruptive regulatory action Goldman Sachs recently reported that the value of cash bond trading has fallen each year over year for the past 5 years. The value of cash bond trading stood at $12,151bn in 2003 and declined to $8,097bn in 2008. The CDS market achieved CAGR exceeding 100% since 2004 and stood at $62tn year end 2007. The inter-dealer market experienced firsthand the decline in secondary market bond turnover and that decline can be correlated directly to the implementation of FINRA's Trade Reporting and Compliance Engine (TRACE) reporting system. TRACE led directly, as an unintended consequence, to the deterioration of OTC inter-dealer investment grade and high yield bond trading volume. While TRACE was anticipated to facilitate the demand for ``transparency'' its implementation revealed the lack of depth in understanding the OTC corporate bond market structure and created an inadvertent level of disclosure that devastated the economic basis for dealer ``market-making''. The lack of a liquid secondary market for corporate debt throughout the term structure of credit spreads dramatically reduces the risk tolerance to underwrite new debt. The underwriters and dealers' facility to trade out of and manage bond risk was so restricted that the unintended consequence was to damage the secondary bond market. This is most notable in the U.S. High Yield bond market. It is not coincidental that the U.S. High Yield bond market reported zero new deal issuance for the month of November 2008. Almost half of U.S. companies have below-investment grade credit ratings, making the $750 billion junk-bond market a critical, if not sole source of financing for an increasing number of corporations large and small all across America.Loss of Money and Capital Markets to Off-Shore Financial Centers The United States is at significant risk to lose the flow of money and capital market trading activities to off-shore financial centers more conducive to over-the-counter market development. While American financial institutions have been the originators of financial innovation that enabled the free flow of capital across international markets, the United States is declining as a recognized financial capital globally. Legislation that creates a regulatory environment that prohibits capital market formation will push market innovation and development to foreign markets, which would be welcoming. Mr. Chairman, Mr. Ranking Member and Members of the Committee, I appreciate the opportunity to provide this testimony today and would urge that you continue to reach out to the dealer market for its input. I am pleased to respond to any questions you may have. Thank you. " FOMC20061212meeting--73 71,MS. PIANALTO.," Thank you, Mr. Chairman. My outlook for the economy hasn’t changed much since our last meeting, but I have become more concerned about the risk to the outlook for real growth. So in my comments this morning, I’ll explain why my risk assessment has changed. The homebuilders with whom I spoke over the past several weeks told me that the low interest rates and the new financial products created an environment in which they did five years’ worth of business in the space of three years. They said that most homebuilders recognized that this pace of activity was unsustainable and so they planned accordingly. A few small builders have declared bankruptcy, and others still may do so; but for the most part, builders feel that they are financially prepared to make it through the next one or two years of poor business. So the financial condition of homebuilders is not my chief concern. However, I have become more worried about the potential spillover of housing conditions into consumer spending from wealth effects, income constraints, and creditworthiness. I think I’m going to give the counterpoint to President Lacker on these issues. The Greenbook points out that the OFHEO price index is still increasing a bit, but the builders I met with convinced me that the published prices for new homes don’t accurately reflect market conditions. Sellers are offering nonprice concessions, such as upgrades for appliances, carpets, fixtures, and so forth. Some builders are going to great lengths to keep published prices up. I’ve been told stories of builders in Arizona who have been giving buyers new Lexuses as part of the overall deal so that they don’t have to bring down the prices in their subdivision. Also, it seems as though owners of existing homes are not yet willing to reduce their asking prices by very much. With potential buyers still waiting for prices to fall further, traffic levels and transactions are low. It seems as though markets are not yet close to functioning smoothly, and homebuilders are telling me that it could take another year before buyers and sellers exhibit more confidence. I am concerned that we don’t yet have a good handle on where house prices are headed and how the uncertainties surrounding house prices might affect consumer spending. Second, the support to consumption provided by cash-out refinancing is not likely to be available going forward to the same degree that we’ve had during the past several years. Finally, the financial condition of some households has become pretty fragile, and we all know that rates on adjustable mortgages, including some subprime mortgage loans, continue to reset at higher rates. The adjustable rate mortgages are already causing some well- publicized problems for some households. Builders in my region report that the ability of potential homebuyers to qualify for home mortgages is becoming an issue. One homebuilder from Columbus told me that he is giving away new cars as well, but his motivation provides a twist on the Lexus story. Some of his customers are struggling to qualify for mortgage loans. So he’s giving them new cars so that they can get rid of their current cars and the payment obligations that go along with them. [Laughter] He’s not giving them a Lexus; he’s giving them a Kia. [Laughter] Now, if we could get these homebuilders to adopt a Buy American strategy, we might also be able to solve our domestic auto problem. As I said at the outset, I don’t have a major disagreement with the Greenbook baseline. I think that the outlook for near-term growth has deteriorated a little since October, and the Greenbook reflects that. I just think that there’s greater likelihood that the real economy could prove to be weaker than the baseline in the Greenbook in 2007, and the key risk in my view is the degree of spillover from the housing market into the rest of the economy. The Greenbook’s extended house decline alternative scenario represents this risk, although I have not yet heard stories that are quite as dramatic as the 20 percent decline in home prices in that scenario. Not much has changed, as many others have already commented, in the inflation outlook. The inflation trend continues to be hard to interpret, but I still expect core inflation to drift down gradually over the forecast period. Although there is still a risk that inflation will remain higher than I desire, I think that favorable compensation developments and declines in shelter costs could speed that rate of decline. Thank you, Mr. Chairman." CHRG-111shrg57319--593 Mr. Killinger," We did use them on the transactions, yes. Senator Levin. Now, in your statement, Mr. Killinger, you described how the Office of Thrift Supervision was on site at WaMu and approved of WaMu's actions, like the decision to raise additional capital. You have mentioned them a number of times, always that they were kind of supporting or approving what you did. What you don't mention in your statement was the Office of Thrift Supervision's criticisms of WaMu. From 2004 to 2008, the Office of Thrift Supervision repeatedly leveled serious criticisms of the bank. Here are a couple samples. In 2004, ``several of our recent examinations,'' they wrote, ``concluded that the bank's single family loan underwriting was less than satisfactory due to excessive errors in the underwriting process, loan document preparation, and in associated activities.'' That was May 12, 2004. In 2005, OTS wrote, ``Underwriting exceptions . . . evidence lack of compliance with bank policy. . . . Deficiencies, if left unchecked, could erode the credit quality of the portfolio. Our concerns are increased with the risk profile of the portfolio. . . .'' In 2006, ``subprime underwriting practices remain less than satisfactory. Continuing weaknesses in loan underwriting at Long Beach.'' In 2007, ``too much emphasis was placed on loan production at the expense of loan quality. Subprime underwriting practices remain less than satisfactory. Underwriting exceptions and errors remain above acceptable levels.'' In 2008, ``poor financial performance exacerbated by conditions within management's control, poor underwriting quality, geographic concentrations in problem markets, liberal underwriting policy, risk layering.'' That was presented to the Board of Directors July 15, 2008. So year after year, you have OTS citing the bank for weak lending practices, and I am wondering, were you aware of those criticisms? " CHRG-111shrg53176--45 Chairman Dodd," Let me quickly invite our next panel, and they have been very patient and had the benefit of sitting and listening to all of this, as well, so they may want to add some addendums to their own testimony. But I am very honored and pleased to present three witnesses who are very familiar with this Committee, have been before us, some of us here on the Committee over the years. Richard Breeden served as Chairman of the Securities and Exchange Commission between 1989 and 1993. In July of 2002, Mr. Breeden was appointed to act as the corporate monitor of WorldCom on behalf of the U.S. District Court overseeing the case involving history's largest corporate fraud and largest bankruptcy. Arthur Levitt, Junior, is the 25th and longest serving Chairman of the SEC, from 1993 to 2001. As Chairman, he created the Office of Investor Education and Assistance, established a Web site which allowed the public free and easy access to corporate filings and investor education materials. Both Chairmen assisted our work, by the way, in Sarbanes-Oxley, going back, and I know both these individuals very, very well. If you needed to have examples, if you wanted to just say, give me an example of good public servants, I offer up the names of Arthur Levitt and Richard Breeden and a look at their work would define, I think, what has been remarkable public service, and successful in the private world, as well. So you bring a wonderful wealth of experience from both sides of the equation. You heard Senator Bennett use the word ``balance'' and others talk about how we strike those balances of wealth creation and having safe and sound financial institutions and a regulatory process. Paul Atkins is the former Commissioner of the Securities and Exchange Commission. He served from 2002 to 2008, and we thank you very much, as well, for joining us and we thank you for your service on the Commission during those years. I guess we begin on a seniority basis here. By seniority, I guess you were the earliest serving, Mr. Breeden, so unless you have worked out something else, we will begin with you and then move right down the line. Thank you all very much, and thank you for your patience in listening to the first panel. STATEMENT OF RICHARD C. BREEDEN, FORMER CHAIRMAN, SECURITIES FinancialCrisisReport--193 The memorandum identified several matters that required resolution prior to a WaMu purchase of Long Beach, including the establishment of pre- and post-funding loan quality reviews that were already in place at the bank. The memorandum also stated that Long Beach management had “worked diligently to improve its operation and correct significant deficiencies … reported in prior years,” and observed, “there is definitely a new attitude and culture.” 724 OTS continued to review Long Beach’s lending practices and found additional deficiencies throughout the year. Those deficiencies included errors in loan calculations of debt- to-income ratios, lack of documentation to support the reasonableness of borrower income on stated income loans, and lack of explanation of a borrower’s ability to handle payment shock on loans with rising interest rates. 725 OTS also determined that Long Beach’s newly created portfolio of subprime loans “had attributes that could result in higher risk” than WaMu’s existing subprime loan portfolio. 726 Nevertheless, in December 2005, OTS examiners wrote that, even though Long Beach was “engaged in a high-risk lending activity and we are not yet fully satisfied with its practices,” they recommended approving WaMu’s purchase of the company with certain conditions. 727 Those conditions included WaMu’s reconsidering its high risk lending concentration limits, including “stated income loans with low FICOs and high LTV ratios”; WaMu’s assurance that Long Beach would comply with certain loan guidance; a WaMu commitment to continue to bring down its loan exception and error rates; and a WaMu commitment to ensure its Enterprise Risk Management division would provide a “countervailing balance” to “imprudent” desires to expand Long Beach’s subprime lending. 728 About the same time as this memorandum was completed, OTS learned that, during the fourth quarter of 2005, Long Beach had been required to repurchase tens of millions of dollars of loans it had sold to third parties due to early payment defaults. 729 By December, this unexpected wave of repurchases had overwhelmed Long Beach’s repurchase reserves, leading to a reserve shortfall of nearly $75 million. Altogether in the second half of 2005, Long Beach had to repurchase loans with about $837 million in unpaid principal, and incurred a net loss of about 724 Id. See also 5/19/2005 OTS email, “LBMC Fair Lending,” OTSWMS05-005 0002002, Hearing Exhibit 4/16-20 (“I would not … feel comfortable with their moving [Long Beach] under the thrift without some conditions”). 725 See 12/21/2005 OTS internal memorandum by OTS examiners to OTS Deputy Regional Director Darrel Dochow, OTSWMS06-007 0001009-16, Hearing Exhibit 4/16-31. 726 Id. at OTSWMS06-007 0001011. 727 See 12/21/2005 OTS internal memorandum by OTS examiners to OTS Deputy Regional Director Darrel Dochow, OTSWMS06-007 0001009-16, Hearing Exhibit 4/16-31. 728 Id. at OTSWMS06-007 0001015-16. 729 See 10/3/2005 OTS Report of Examination, OTSWMS06-010 0002530, Hearing Exhibit 4/16-94 [Sealed Exhibit] (noting that, after a field visit to Long Beach that concluded in December 2005, OTS learned that loan repurchases had surged: “Subsequent to our on-site field visit, management informed us that loan repurchases had increased considerably. … Management indicated that approximately $0.6 billion in loans were repurchased during the fourth quarter of 2005 out of approximately $13.2 billion in total whole loan sales. The gross financial impact at December 31, 2005, was $72.3 million.”); 1/20/2006 email from Darrel Dochow to Michael Finn and others, with chart, OTSWMS06-007 0001020 to 1021 (describing Long Beach repurchases). $107 million. 730 In response, its auditor, Deloitte and Touche, cited Long Beach for a CHRG-110hhrg44900--183 Mr. Bernanke," We will certainly provide you with all the important information, the relevant information, associated with our contract with Black Rock. They are one of our relatively few number of firms that could address the needs that we have; and, given the exigencies of the weekend, it was obviously beneficial that we could get their services in a very short-term notice. We will be reviewing these conditions and terms and try to ascertain whether any additional steps are necessary. I can't at this point, I guess at this point, it's not an immediate plan to change the company as they have been working very effectively for us. We think that it has been a good arrangement with them at this point. " FOMC20070810confcall--44 42,CHAIRMAN BERNANKE.," Are there any other questions? Okay. Thank you for your questions and comments. This is what we’re going to do now. There are additional things that we might consider in the future if problems continue or worsen—for example, a swap line to provide more dollar liquidity to Europe; a reduction in the discount rate; and then if we decide that the macroeconomic conditions warrant it, a change in the federal funds rate. Those things would require FOMC approval. So obviously, should we get to the point at which we want to take additional steps, we will be in touch with you, and if you have any further comments or questions, please let us know. Is there anything else? President Plosser." FOMC20080318meeting--67 65,MR. PLOSSER.," Thank you, Mr. Chairman. As anticipated, Third District business activity showed continued weakness in February and March. Reports from retailers, manufacturers, bankers, and other business contacts remain somewhat downbeat. At the same time, there has been little moderation in price pressures facing our firms and consumers. There is little new in the regional housing markets. So rather than dwell on housing, let me talk about some of the information that we have received since our last meeting. Banks in the Third District have generally been relatively unscathed by the toll on the financial markets. Many had not been in the subprime market and did not have instruments based on subprime. They do, however, hold a high proportion of commercial real estate and residential mortgage loans in their portfolios. So to the extent that the commercial real estate market slows as we expect, our banks are likely to be feeling the effects. Bankers, thus, have become somewhat more pessimistic over the past six weeks or so. They don't expect financial conditions to improve any time soon, and several noted signs of declining business loan demand, which they had not been seeing earlier. Bankers also report some deterioration in personal-loan credit quality and are expecting increases in credit card delinquencies. Despite these increases, these delinquencies and default rates so far remain well within historical norms. Manufacturing outlook activity in the District remains weak. Our March business outlook survey is confidential until we release it this coming Thursday. It will show a little improvement in February's dismal readings. Since the beginning of the year, the general activity index has been at a level typically associated with either a national recession or a substantial slowdown in economic growth. So despite the modest improvement, it doesn't move us out of negative territory. Responses to a special survey question in February indicate that the majority of our firms considers their inventories to be at an appropriate level, and firms are unlikely to substantially replenish these inventories until midyear or later. But it doesn't seem as though there will be more-dramatic reductions in inventories--as, for example, in the Greenbook's basic story, where there's a very large inventory correction, it appears. Despite the weakness in activity, there has been little moderation in price pressures in the District. The current prices-paid index in our business outlook survey continues to accelerate, and both the prices-paid and prices-received indexes over the past three months are at very high levels relative to the last twenty years. Firms in various sectors, not just manufacturing, were reporting significant increases in prices, particularly of imported inputs. Although our firms are expecting continued weak real activity, they expect prices to rise over the next six months. Indeed, the forward-looking price indexes in the survey are at very elevated levels, and the future-prices-paid index is at its highest level since the early 1980s. Our firms seem to be as skeptical as I am of the arguments of the critical link between inflation and resource utilization. Turning to the national outlook, I struggled coming into this meeting with a growing level of discomfort. There are four dimensions to my concerns: first, the outlook for growth; second, the outlook for inflation; third, the calibration of monetary policy given that outlook; and fourth, the turmoil in the financial markets. First, in terms of near-term economic growth, the outlook has deteriorated somewhat since our last meeting. I expected weak growth in the first half of the year, but the incoming data suggest that growth will probably be somewhat weaker than I anticipated. I and many private-sector forecasters, like the MA or the Blue Chip survey summaries, have responded to the incoming data with downward revisions to our forecast for certainly the first half of 2008. But our changes are considerably smaller than the revisions in the Greenbook's forecast, which have revised down personal consumption in 2008 from 2.3 percent in the January forecast to zero in the current forecast while incorporating significantly more monetary policy stimulus. I realize that the Board's staff has a good track record, but I am not wholly comfortable with the Greenbook's forecast, which I think incorporates a number of judgmental adjustments that are responsible for taking it pretty far away from where private-sector forecasts now are. Second, I'm just less comfortable with the inflation outlook. I've said before that, if inflation expectations become unhinged, we will face an even more difficult problem as monetary policy will feed more quickly and directly into higher inflation outcomes. The ensuing loss of credibility will be costly to regain. I wish we had the luxury of waiting for unambiguous evidence that expectations have lost their anchor. But if we wait until then, it will be too late. This means that we have to look for early warning signs so we can take appropriate action to ensure that expectations remain anchored, and I am concerned that we are seeing those warning signs. Despite last Friday's CPI numbers, headline and core inflation have been trending up. Oil prices are at record highs. Commodity prices continue to trend up, and the dollar has fallen sharply. Our business and consumer contacts are consistently stressing price pressures as a concern. These developments concern me partly because research indicates that inflation actually may have become less persistent since the 1990s, and I think we have to be careful not to interpret the lack of persistence independent of what monetary policy actions are taken. Moreover, inflation expectations measured by surveys and market-based measures have all risen over the last couple of months. Inflation risk premiums have risen, which could be an early warning signal of a waning credibility or commitment on the part of the Fed. The National Association for Business Economics survey in early March shows that a third of the respondents think that monetary policy is now too stimulative, and that is up from less than 10 percent just a few months ago. According to a special question on our November Survey of Professional Forecasters--I reported on this several meetings ago--half of those forecasters, 23 out of the 45, believe that the FOMC has an inflation target. Of those 23 forecasters, 20 believe that long-run inflation over the next ten years will be 50 basis points or more above what they view our inflation target is. I might be able to shrug off one or two of these, but the predominance of these signals has me concerned about the risk to our credibility. I'm also concerned that the public seems to perceive that the Fed has effectively set aside one part of its mandate, price stability, in our all-out efforts to promote economic growth. Said differently, it seems to suggest that not only are we incorporating new data into our loss function as our forecasts change but we are changing the coefficients on that loss function. I don't believe that we are necessarily doing that, and I don't believe that's the right way to make policy, but I do believe that ultimately it's up to us to make that clear to the public as best we can. Third, we have to calibrate the appropriate level of the funds rate and not just its rate of change. This is not an easy task, especially in the current circumstances. We have reduced the targeted funds rate by 225 basis points since August and 125 basis points in just the last six weeks. It is simply too soon for the economy to have felt the full effects of these rate cuts. While the recent deterioration in the outlook might suggest that we need easier policy, I believe that the recent increases in inflation expectations mean that the real funds rate has already fallen either below zero or close to zero depending on how we measure it. For example, the real funds rate is now minus 1 percent, which is below the more pessimistic Greenbook-consistent r* of minus 0.5 percent given in the Bluebook, if you measure the real rate as the nominal funds rate minus the Greenbook's one- quarter-ahead forecasted headline PCE. The Greenbook suggests that the real funds rate can be negative over the next two years and inflation will continue to decelerate as upside inflation pressure is offset by greater slack in product and labor markets. I am skeptical. This outcome is predicated on inflation expectations remaining well anchored despite aggressive and persistent easing for a sustained period of time. Given the current fragility of inflation expectations, this seems very unlikely to me. The alternative Greenbook scenario with more inflation pressure from oil and imported goods suggests a steeper policy path and higher inflation by 2010-12. Fourth and finally, like everyone else, I am very concerned about the developments in the financial markets. I've been supportive of the steps we've taken to enhance liquidity in the markets through the TAF, the TSLF, the PDCF, or whatever. " CHRG-111shrg54589--137 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM MARY L. SCHAPIROQ.1.a. Do you believe the existence of an actively traded cash market is or should be a necessary condition for the creation of a derivative under law and regulation?A.1.a. The primary function of derivatives is to facilitate the efficient transfer of risk exposure among market participants. Trading of risk exposure through derivatives enables parties who have natural risk exposures as part of their business or investment operations to reduce or eliminate that risk by transferring it to somebody who has a natural offsetting risk, or to somebody else who is more willing to bear that risk. Some sources of fundamental business risk are closely related to the prices of assets that are traded in an active cash market, such as stock or foreign currency. Other risks lack robust cash market pricing sources. Derivatives based on these risks, however, can be important tools for managing these risks. As with any derivative product, the key challenge for policy makers will be determining when and whether the value of these products for risk management purposes outweighs potential concerns about the products' underlying market integrity.Q.1.b. If not, what specific, objective means besides a cash basis market could or should be used as the underlying relationship for a derivative?A.1.b. This issue raises important public policy concerns. Products without an active cash or derivatives market may have less robust price discovery. These products, nevertheless, may be useful to hedge or transfer real economic risks and, therefore can play a beneficial role in facilitating risk management and risk transfer activities. Policy makers should consider whether risk management and distribution purposes outweigh concerns with weak or unreliable pricing sources. Traditionally, the SEC has used disclosure to identify valuation risks associated with securities.Q.2. Why should the models to price OTC derivatives not be published? If there is no visible cash basis for a derivative, and the model is effectively the basis, why should the models not be public?A.2. The best way to improve market understanding and ``value'' determinations for derivatives is to standardize and centrally clear them (to the extent possible) and encourage them to be traded on exchanges. This would provide great transparency. Where standardization or exchange trading is less likely, I believe policy makers should endeavor always to maximize market transparency through reporting or other mechanisms. The argument for making models public when no cash market exists is an interesting way to provide a valuation check, but there are costs to this approach as well. For example, would investors continue to innovate and alter their models if they were public and available to their competitors? Would models become more similar--decreasing market style diversity and increasing the risk that major participants engage in the same trades (increasing volatility and risk)?Q.3. What is the best way to draw the line between legitimate hedges and purely speculative bets? For example, should we require an insurable interest for purchasers of credit protection, require delivery of the reference asset, or something else?A.3. Drawing a line, based on trading positions, between hedgers and speculators will necessarily be arbitrary because we cannot determine the intent of a trader from their portfolio holdings. Some market participants will hold derivative positions as part of a well-defined hedge (e.g., they also have large current or anticipated exposure to the prices of securities or debt instruments). Others have no exposure at all and hold a derivatives position strictly to gain exposure, that is to speculate, on price movements. However, drawing a line between the two motives is difficult and may yield unintended consequences. First, there are a number of entities that do not hold large securities or debt holdings, who may, nonetheless have a legitimate risk management purposes: For example, they may want to hedge their ``exposure'' to a major supplier or customer. Second, even if a reasonable line is drawn, there may be significant market consequences: For example, ``speculators'' can often provide liquidity for hedgers--so eliminating speculators can raise the cost of risk management and make hedges less effective. In developing a regulatory framework for OTC derivatives these and other complexities will need to be addressed in a manner that seeks to prevent the potential for market abuses while also creating a system that facilitates legitimate transactions.Q.4. Is the concern that increased regulation of derivatives contracts in the United States will just move the business overseas a real issue? It seems to me that regulating the contracts written in the U.S. and allowing American firms to only buy or sell such regulated contracts would solve the problem. What else would need to be done?A.4. Clearly we need to move forward with our regulatory framework, even if other jurisdictions do not follow. However, financial markets today are global markets and coordinating with our international counterparts will be critical. Absent a response coordinated with foreign regulators exercising similar authority, the effectiveness of any regulatory limits would be constrained significantly by the international nature of the derivatives market. Because there is the potential for trading business to move to less regulated markets, we are working with our counterparts internationally to ensure that all derivatives dealers and large participants in OTC derivatives market are subject to prudential regulation and supervision.Q.5. Do over-the-counter or custom derivatives have any favorable accounting or tax treatments versus exchange traded derivatives?A.5. There is no difference in the financial statement accounting principles applied to exchange traded versus other types of derivatives. With respect to the financial accounting treatment, contracts or other arrangements that meet the accounting definition of a derivative are ordinarily recognized and measured at fair value with changes recognized in income each period whether the derivative is exchange traded or customized. However, accounting rules allow companies to achieve hedge accounting and defer recognizing the impact of changes in value of derivatives used for hedging purposes when changes in the value of a derivative match and offset changes in the value of the hedged item to a sufficient degree. It is possible, in some cases, that a customized derivative may be more likely to economically offset changes in the value of the exposure a company is trying to hedge. Thus for certain applications, customized derivatives may be more likely to offset the exposure and thus may be more likely to meet the requirements for hedge accounting. In all cases where a derivative serves as a highly effective hedge, accounting standards clearly permit the entity to reflect the reduction in risk in the measurement of income.Q.6. In addition to the Administration's proposed changes to gain on sale accounting for derivatives, what other changes need to be made to accounting and tax rules to reflect the actual risks and benefits of derivatives?A.6. Even before the credit crisis, financial accounting for derivatives had been identified as deserving additional consideration. In this regard, the Financial Accounting Standards Board (FASB) issued new disclosure requirements in 2008 that provide greater transparency about derivative and hedging activities to investors, including a substantial amount of additional information about credit default swaps. Derivatives accounting also represents a component of the FASB's current project to reconsider the accounting principles for all financial instruments, recently undertaken in concert with the International Accounting Standards Board. This project was added to the FASB's agenda, in part, as a response to issues identified by the SEC and others during the credit crisis. Many have argued that the hedge accounting rules are overly complex and could be improved to make hedge accounting easier to apply and more understandable to investors. While we are supportive of such simplification, we would expect that because of their volatile nature, derivatives will continue to be measured at fair value each period on the balance sheet, and significant disclosures will continue to be needed for investors to understand the exposures, strategies, and risks of companies that utilize them. The tax treatment of different types of derivatives is outside of the SEC's area of expertise and may be better addressed by tax professionals and/or the IRS.Q.7. Should parties to derivative contracts be required to post cash collateral, or is other collateral acceptable? And is there any reason not to require segregation of customer collateral?A.7. Provided that positions are marked to market and collateral calls are made daily, cash collateral is one prudent type of collateral. In certain circumstances, though, highly liquid securities that tend to move in price consistent with the underlying reference asset may be as desirable for collateral as cash. Guidelines for acceptable forms of collateral will need to reflect the risks and circumstances associated with each type of acceptable collateral, including, but not limited to, price volatility and liquidity, and be agreed to by both parties to the transaction. Accordingly, under certain circumstances, noncash collateral may be acceptable. A priority of a regulatory framework for OTC derivatives should be ensuring a process that allows for the prompt return of customer collateral. Properly constructed regulations governing the segregation of customer collateral can provide customer protection while still promoting the operation of efficient OTC derivatives markets.Q.8. Is there any reason standardized derivatives should not be traded on an exchange?A.8. In building a framework for the regulation of OTC derivatives, the goal should be to encourage all standardized derivatives to be traded on exchange or equivalent exchange-like venues that provide full regulatory and market transparency. The regulatory scheme for trading OTC derivatives should be designed to achieve vital public policy objectives for such instruments, including transparency, efficiency, and prevention of fraud and manipulation. The regulatory scheme for standardized derivatives should, however, retain sufficient flexibility to allow market mechanisms to develop that meet varying trading needs for products (such as products that may lack sufficient liquidity to be traded on an exchange), while ensuring all dealers and trading markets (including for nonstandardized products) are subject to a unified regulatory scheme that establishes a framework for fair competition among markets, protects the public interest and is sufficiently transparent to allow for regulatory oversight.Q.9. It seems that credit default swaps could be used to manipulate stock prices. In a simple example, an investor could short a stock, and then purchase credit default swaps on the company. If the swaps are not heavily traded, the purchase would likely drive up the price of the swaps, indicating higher risk of default by the company, and lead to a decline in the stock price. Is there any evidence that such manipulation has taken place? And more generally, what about other types of manipulation using derivatives?A.9. The Commission is very concerned about potential manipulation of the equity markets through the use of credit default swaps or other derivative instruments. Because there is no central reporting or audit trail requirement for OTC derivatives, including securities-related OTC derivatives, there is no organized surveillance by any Federal regulatory agency or self-regulatory organization. This regulatory gap substantially inhibits the Commission's examination and enforcement efforts, and the lack of surveillance creates substantial risk to the markets collaterally affected by swap transactions, such as the market for debt and equity securities related to credit default swaps. The antifraud prohibitions in the Federal securities laws currently apply to all securities-related OTC derivatives, including credit default and other swaps related to securities. The Commission, however, needs better tools to enforce existing prohibitions over all securities-related OTC derivatives, including authority to promulgate reporting and record keeping rules and prophylactic antifraud rules. Currently, if Commission enforcement or examination staff suspects illegal conduct in the derivatives market, staff must engage in the time-consuming process of manually recreating activity in this unregulated market, which is challenging in a market without uniform documentation, transparent pricing, and time-stamped records. Under these circumstances, it is difficult to identify violations and prove the intent required to support charges under the Federal securities laws. Uniform record keeping and reporting would provide the type of information needed to identify suspicious trading patterns and to investigate or examine misconduct. With uniform audit trail and record keeping requirements, Commission staff could, for example, better pinpoint where manipulative credit derivative trading occurs in tandem with other trading strategies, such as short selling.Q.10. Credit default swaps look a lot like insurance when there are unbalanced, opportunistic sellers. However, life and property insurance requires an insurable interest for the buyer and reserves for the seller. Why should we not regulate these swaps like traditional insurance?A.10. Although credit default swaps are frequently described as insurance (buying protection against the risk of default) and may have certain elements similar to traditional insurance, we believe that securities-related credit default swaps are more appropriately considered, and regulated, as securities. The value of the payment in the event of default is determined by reference to a debt security, so that the payment is tied directly to a security. As noted in the CDS example in question #9, securities-related credit default swaps are tied directly to the securities markets and issuers of securities. As a result, manipulative activities in the credit default swap market would affect U.S. issuers in the underlying equity market. Congress recognized the impact of these instruments on the primary markets that are regulated by the SEC when it applied the antifraud and antimanipulation provisions of the securities laws to securities-related OTC derivatives, such as securities-related credit default swaps, in 2000. That authority needs to be extended to provide the SEC the regulatory tools to regulate these products. Regulating securities-related credit default swaps as insurance would actually undermine the protections provided by the Federal securities laws by creating the potential for arbitrage between two different types of regulation for economically related products.Q.11. How do we take away the incentive for credit default swap holders to force debtors into bankruptcy to trigger a credit event rather than renegotiate the debt?A.11. Some commenters have identified a phenomenon they characterize as the ``empty creditor'' problem. These commenters have noted that credit default swaps, among other products, allow a creditor holding a debt obligation to reduce or eliminate its economic exposure to the debtor while still retaining the rights as a creditor. As a result, creditors who hold significant credit default swap positions may prefer that the debtor enter into bankruptcy because the creditor will receive payments in connection with its CDSs that exceed any benefit the creditor would get if the debtor restructured its debt. The Federal securities laws do not establish any duties of a creditor to a lender or to other creditors. The motivation of a creditor to take any action with respect to its debt holdings in a particular company may be guided by many different economic and investment factors that are unique to such creditor, with credit default swaps being just one such factor. For example, a creditor that also is a significant equity holder may have different motivations in making credit decisions as compared to a creditor that holds only debt. Focusing only on a creditor's actions as influenced by its holding of credit default swaps does not take into account these other motivating factors.Q.12. How do we reduce the disincentive for creditors to perform strong credit research when they can just buy credit protection instead?A.12. As the financial crisis illustrates, it certainly appears that some major market participants may have used credit protection as an alternative to engaging in more robust traditional credit research and review regarding their credit exposures--leading to hidden/higher credit risk and the risk that the credit protection provider cannot perform. This tension is real. However, this moral hazard that exists in credit protection exists in a number of contexts in the financial arena. For example, this hazard exists when investors rely on a credit rating or an analyst's research report instead of engaging in their own research. Although inherent, this problem is exacerbated by a number of factors in the credit arena--such as when information is limited to a small number of creditors or unavailable to the public; when traditional credit standards are reduced; or when investors and creditors become less vigilant due to perceptions (or misperceptions) of market safety. In the short term, the financial crisis itself has certainly reduced these risks, but it is important that regulators (as well as investors and other market participants) remain vigilant to help avoid the next crisis. To better ensure that vigilance, we believe more accountability and transparency will do a lot to keep investors informed of the flaws of overreliance on credit protection, credit ratings, or a similar third-party validator before making investment or credit decisions.Q.13. Do net sellers of credit protection carry that exposure on their balance sheet as an asset? If not, why shouldn't they?A.13. Sellers of credit protection typically carry a liability on their balance sheets for the obligation to compensate the guaranteed party if a credit event occurs on the referenced asset. Some types of credit protection are considered insurance contracts under the accounting rules and the resulting obligation is measured based on insurance accounting principles. Other types of credit protection, such as credit default swaps, meet the accounting definition of a derivative and the resulting liability is marked to market each period. Unless an insurer or guarantor controls the referenced asset, accounting rules do not permit or require the referenced assets to be recognized on the guarantor's balance sheet. In other words, simply guaranteeing or insuring the value of an asset does not require a guarantor to record the insured asset on its balance sheet under generally accepted accounting principles. On the other hand, guarantors that control the insured or guaranteed assets will generally be required under new off-balance sheet accounting rules to report on their balance sheets the controlled assets effective for 2010 financial reports.Q.14. In your testimony you mentioned synthetic exposure. Why is synthetic exposure through derivatives a good idea? Isn't that just another form of leverage?A.14. Synthetic exposure through derivatives can be a good idea, or a bad idea--depending on the circumstances. While they can be used to increase leverage, they can also be used to reduce transaction costs, achieve tax efficiencies, or manage risk. Synthetic exposure through derivatives is a component of many arbitrage strategies that help align prices of related assets across markets. A key question for policy makers, I believe, will be determining how best to utilize the ``good'' aspects of derivatives use (e.g., as a risk management tool for individual institutions); while minimizing the ``bad'' aspects (unclear pricing, hidden leverage, and increased counterparty and systemic risk). It is also important to keep in mind that when synthetic exposure through securities-related derivatives products is used to replicate the economics of either a purchase or sale of securities without purchasing or selling the securities themselves, the markets for these derivatives directly and powerfully implicate the policy objectives for capital markets that Congress has set forth in the Federal securities laws, including investor protection, the maintenance of fair and orderly markets, and the facilitation of capital formation. Given the impact on the regulated securities markets--and the arbitrage available to financial engineers seeking to avoid oversight and regulation--it is vital that the securities laws apply to securities-based swaps.Q.15. Regarding synthetic exposure, if there is greater demand for an asset than there are available assets, why shouldn't the economic benefit of that demand--higher value--flow to the creators or owners of that asset instead of allowing a dealer to create and profit from a synthetic version of that asset?A.15. This is an interesting question. I believe policy makers should consider carefully whether/how the creation of these synthetics affect demand for the underlying securities. Traditionally, the view is that dealers and other financial intermediaries provide liquidity to the market and help make markets more efficient by reducing the extent to which asset prices are subject to excess volatility that may arise from short-term trading imbalances. The ability of liquidity providers to improve market quality is significantly enhanced when they are able to engage in activities that involve synthetic exposure. Constraints on the ability of intermediaries to provide liquidity increase the propensity for asset prices to deviate significantly from fundamental value. These deviations can lead to a misallocation of capital, and can be harmful to the investors. For example, investors are harmed when they buy an asset at a price that is temporarily inflated due to a demand shock.Q.16. One of the arguments for credit default swaps is that they are more liquid than the reference asset. That may well be true, but if there is greater demand for exposure to the asset than there is supply, and synthetic exposure was not allowed, why wouldn't that demand lead to a greater supply and thus more liquidity?A.16. On average, large debt issues tend to be more liquid than small ones because they tend to be held by a greater number of investors and there are more units available for trading. This does not mean, however, that an issuer would have the ability to improve the liquidity of its bond issue by issuing more debt. Market liquidity depends mainly on the ability and willingness of financial intermediaries to take on inventory positions in response to demand shocks.Q.17. Is there any justification for allowing more credit protection to be sold on a reference asset than the value of the asset?A.17. The primary justifications I have seen for permitting the purchase of credit protection beyond an entity's ``exposure'' are (1) these participants provide liquidity to those who are themselves hedging; (2) a participant may use credit protection based on one reference asset to hedge risks on other related assets; and (3) investors may wish to take a position expressing a view that the market is underestimating the probability or severity of default.Q.18. Besides the level of regulation and trading on an exchange, there seems to be little difference in swaps and futures. What is the need for both? In other words, what can swaps do that forward contracts cannot?A.18. The term ``swap'' generally refers to over-the-counter derivative instruments, a category that encompasses a wide range of products, including forward contracts, interest rate swaps, total return swaps, equity swaps, currency swaps, credit default swaps and OTC options, including both traditional and digital (or binary) options. In contrast, futures are a specific kind of standardized, exchange-traded derivative. Swaps may be tailored to address specific risks in ways not available with standardized products such as futures. For example, customized swaps involving foreign currency, interest rates, and hard commodities may play an important risk management role for companies and other end users because standardized contracts, in these circumstances, may not address the needs of a company with respect to the specific risks being hedged.Q.19. One of the arguments for keeping over-the-counter derivatives is the need for customization. What are specific examples of terms that need to be customized because there are no adequate substitutes in the standardized market? Also, what are the actual increased costs of buying those standard contracts?A.19. Commercial businesses will often individually customize OTC derivatives to meet the company's specific risk management needs. Companies may use OTC derivatives to manage fluctuations in materials prices, equity OTC contracts, commodities, fuel, interest rates and foreign currency. For example, a company that borrows money at a variable interest rate might enter into derivatives contracts to turn the borrowing into fixed-rate debt or as protection against swings in currencies or the price of commodities such as food and oil. The company can customize the contract to mature on a specific date or for a nonstandard notional amount, creating a more effective hedge. The inability to create perfect hedges can introduce basis risk. Basis risk can also occur when the asset being hedged is different from underlying asset of the derivative that is being used to hedge the exposure. Allowing firms to continue to bilaterally negotiate customized OTC derivatives contracts can help mitigate these risks. Standardizing OTC derivatives may increase costs in certain instances and decrease costs in others. Standardized derivatives, particularly those that are cleared through central counterparties, require the posting of cash or cash equivalent collateral. This is a cost not faced by financial firms when they enter into OTC derivatives contracts with other large financial firms. Conversely, standardizing OTC derivatives could result in tightening of the bid-ask spread of the instruments due to fewer individual terms that need to be negotiated between counterparties. This could potentially lower costs faced by purchasers and sellers of those contracts. Standardization could also lead to less effective hedges, but would allow a party to trade out of its position as opposed to negotiating a separate termination agreement. These termination agreements can be extremely expensive for the party seeking to exit customized deals.Q.20. On the second panel, Mr. Whalen suggests that Congress should subject all derivatives to the Commodity Exchange Act, at least as an interim step. Is there any reason we should not do so?A.20. To the extent that derivatives are securities-related, the securities laws should continue to apply. Without application of the securities laws, the derivatives market could be used to manipulate the securities market by circumventing securities laws protection against insider trading and improper short selling, among other things. Secretary Geithner recognized that multiple Federal regulatory agencies should play critical roles in implementing the proposed framework, including the SEC and the CFTC. In my testimony, I recommended that primary responsibility for ``securities-related'' OTC derivatives be retained by the SEC, which is also responsible for oversight of markets affected by this subset of OTC derivatives. Primary responsibility for all other OTC derivatives, including derivatives related to interest rates, foreign exchange, commodities, energy, and metals, could rest with the CFTC.Q.21. There seems to be agreement that all derivatives trades need to be reported to someone. Who should the trades be reported to, and what information should be reported? And is there any information that should not be made available to the public?A.21. We agree that all derivatives trades should be reported. Information reported should include the identity of the contract traded, the size of the contract, the price, the parties to the contract (and which party was the buyer and which was the seller), and the time of trade. Additional analysis by appropriate regulators may identify other data elements that should be reported. Where a trade is reported depends on where it is traded. If a product is traded on a regulated exchange or an exchange-like facility (such as an alternative trading system), the details of the trade will be captured by the trading system. If a product is traded elsewhere, trades in that product should be reported to another regulated entity, such as a trade repository or self-regulatory organization. Entities to which trades are reported could disseminate information to the public individually. This approach would likely be the easiest to implement in the near term. However, it would mean that trading and reporting data would be fragmented, and it is unclear how easily or well it could be aggregated by private data vendors. Different entities could adopt different standards for trade reporting and dissemination (such as adopting different identification codes for the same derivatives contracts). Significant regulatory efforts could be necessary to promote uniform standards for these various entities to obtain the full benefits of post-trade reporting and transparency. One way to address these potential problems would be for the appropriate regulator to designate a central information processor to collect trade input from various sources and to disseminate trade information publicly in a uniform manner and subject to regulatory standards that ensure that access to the trade data is on terms that are fair and reasonable, and not unreasonably discriminatory. The SEC relies on and regulates such central information processors in the markets for cash equities, securities options, corporate debt securities, and municipal securities. We believe that these trade reporting and dissemination systems work very well and deliver a robust information stream in a timely and cost-efficient manner. As your question notes, some information that is reported may not be appropriate for public dissemination. One such item may be the names of the counterparties. The systems for cash equities, securities options, corporate debt securities, and municipal debt securities that are regulated by the SEC currently do not disseminate such information.Q.22. Is there anything else you would like to say for the record?A.22. I appreciate the opportunity to testify on this important topic and I look forward to working with the Committee to fill the gaps in regulation of OTC derivatives. These efforts are critical to furthering the integrity of the U.S. capital markets. ------ CHRG-111hhrg51592--8 Mr. Bachus," I thank the chairman. It's not normally my tendency to be overly critical, but I'm going to make an exception in this case. I think surely everyone now recognizes that the credit rating agencies have failed, and failed spectacularly and broadly. Inaccurate rating agency risk assessments are one of the fundamental factors, in my opinion, in the global financial crisis, and effective correction action must address these shortcomings. As Mr. Ackerman alluded to, the rating agencies say that these assessments or ratings are opinions, predictive opinions, and I think from a legal standpoint, that's true. But in the real world, that's not reality. The SEC special examination report of the three major credit rating agencies uncovered significant weaknesses in their rating practices for mortgage-backed securities, and also called into question the impartiality of their ratings. As the SEC report detailed, the rating agencies failed to accurately rate the creditworthiness of many structured financial products. Investors and the government both over-relied on these inaccurate ratings, which undoubtedly contributed to the dramatic collapse of the United States and its financial market, or near-collapse. In order to avoid future meltdowns, we must return to a time where the rating agencies are not deemed a valid substitute for thorough investor due diligence. My own view is that while the SEC report did not address municipal securities, the rating agency practices were also significant factors in the problems that plagued municipal issuers. The Federal Government must also share the blame for fostering over-reliance on rating agencies. The Federal Reserve's recent designation of certain rating agencies as major nationally recognized statistical rating organizations implies a government stamp of approval that does not exist. What we have is what I would call, and others have called, a government-sanctioned duopoly. I think that's a mistake. As we move forward with regulatory reform proposals, the committee should consider removing from Federal laws, regulations, and programs all references that require reliance on ratings. The SEC also should take action to remove similar references in its own rules as quickly as possible. At a minimum, the committee should consider changing NRSROs from nationally recognized to nationally registered statistical rating organizations, to further reduce the appearance of government support or approval. As Mr. Garrett said, I think credit swap derivatives have been an accurate predictor of credit risk, and more so than credit ratings, and the credit ratings have become almost--well, I won't go into all that, but what I would say, this should give us caution in discouraging the use of credit default swaps, and it's critical that this committee doesn't restrict these CDS contracts in the marketplace as we consider broader regulatory reform. Let me close by saying, to say what has occurred in the marketplace since 2006 has been volatile and frightening is an understatement. Correcting inadequacies of the credit rating process is absolutely essential to restoring investor confidence. There must be further changes in the current rating system to respond to very serious concerns expressed by investors, market participants, and policymakers alike. I look forward to hearing from the witnesses concerning these matters. Thank you, Mr. Chairman. " FinancialCrisisReport--89 To address the problem, WaMu invested millions of dollars in a technology program called Optis, which WaMu President Rotella described in the end as “a complete failure” that the bank “had to write off” and abandon. 272 In 2004, an OTS Report of Examination (ROE), which was given to the bank’s Board of Directors, included this observation: “Our review disclosed that past rapid growth through acquisition and unprecedented mortgage refinance activity placed significant operational strain on [Washington Mutual] during the early part of the review period. Beginning in the second half of 2003, market conditions deteriorated, and the failure of [Washington Mutual] to fully integrate past mortgage banking acquisitions, address operational issues, and realize expectations from certain major IT initiatives exposed the institution’s infrastructure weaknesses and began to negatively impact operating results.” 273 The records reviewed by the Subcommittee showed that, from 2004 until its shuttering in 2008, WaMu constantly struggled with information technology issues that limited its ability to monitor loan errors, exception rates, and indicators of loan fraud. From 2004 to 2008, WaMu’s regulators also repeatedly criticized WaMu’s failure to exercise sufficient oversight of its loan personnel to reduce excessive loan error and exception rates that allowed the issuance of loans in violation of WaMu’s credit standards. 274 In 2004, Craig Chapman, then the President of WaMu Home Loans, visited a number of the bank’s loan centers around the country. Lawrence Carter, then OTS Examiner-in-Charge at WaMu, spoke with Mr. Chapman about what he found. Recalling that conversation in a later email, Mr. Carter wrote: “Craig has been going around the country visiting home lending and fulfillment offices. His view is that band-aids have been used to address past issues and that there is a fundamental absence of process.” 275 The regulators’ examination reports on WaMu indicate that its oversight efforts remained weak. In February 2005, OTS stated that WaMu’s loan underwriting “has been an area of 272 Subcommittee interview of Steve Rotella (2/24/2010). 273 See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001482, Hearing Exhibit 4/16-94 [Sealed Exhibit]. See also, e.g., 12/17/2004 email exchange among WaMu executives, “Risks/Costs to Moving GSE Share to FH,” JPM_WM05501400, Hearing Exhibit 4/16-88 (noting that Fannie Mae “is well aware of our data integrity issues (miscoding which results in misdeliveries, expensive and time consuming data reconciliations), and has been exceedingly patient.”). 274 See, e.g., OTS examination reports cited in Chapter IV, below. 275 8/13/2004 email from Lawrence Carter to Michal Finn, Finn_Michael-00005331. concern for several exams.” 276 In June 2005, OTS expressed concern about the bank’s underwriting exceptions and policy compliance. 277 In August of the same year, the OTS Report of Examination stated that, “the level of deficiencies, if left unchecked, could erode the credit quality of the portfolio,” and specifically drew attention to WaMu concentrations in higher risk loans that were a direct result of its High Risk Lending Strategy. 278 2006 was no better. OTS repeatedly criticized the level of underwriting exceptions and errors. 279 CHRG-109shrg30354--45 Chairman Shelby," Mr. Chairman, last question here for now, dealing with the housing market GSE's. In your testimony this morning, you note the cooling down in the housing market and its associated effect perhaps on consumer spending. What effect, Mr. Chairman, if any, would a more significant slow down in the housing market and asset-based securities industry have on the financial condition of Freddie Mac and Fannie Mae? And do you have any concerns regarding effects on the banking system in this regard? " CHRG-111shrg51290--62 PREPARED STATEMENT OF ELLEN SEIDMAN Senior Fellow, New America Foundation and Senior Vice President, ShoreBank Corporation March 3, 2009 Chairman Dodd, Ranking Member Shelby and members of the Committee. I appreciate your inviting me here this morning to discuss consumer protection and oversight in the financial services industry in the context of the current economic crisis, and to provide my thoughts on how the regulatory system should be restructured to enhance consumer protection in the future. In quick summary, I believe that the time has come to create a well-funded single Federal entity with the responsibility and authority to receive and act on consumer complaints about financial services and to adopt consumer protection regulations that would be applicable to all and would be preemptive. However, I believe that prudential supervisors, in particular the Federal and State banking regulatory agencies, should retain primary enforcement jurisdiction over the entities they regulate. My name is Ellen Seidman, and I am a Senior Fellow at the New America Foundation as well as Executive Vice President, National Program and Partnership Development at ShoreBank Corporation, the nation's first and leading community development bank holding company, based in Chicago. My views are informed by my current experience--although they are mine alone, not those of New America or ShoreBank--as well as by my years at the Treasury Department, at Fannie Mae, at the National Economic Council under President Clinton, and as Director of the Office of Thrift Supervision from 1997 to 2001. During my tenure at OTS, we placed significant emphasis on both consumer and compliance issues and on the responsibility of the institutions we regulated to serve the communities in which they were chartered, both because of their obligations under the Community Reinvestment Act and because it was good business. We paid particular attention to compliance, building up our staff and examination capability, establishing a special award (done away with by my successor) to honor the best performer in compliance and community affairs, reaching out to consumers and communities, and enhancing our complaint function. We were by no means perfect, but we worked to put compliance on an equal footing with safety and soundness. Since I left OTS, I have spent much of my time working on issues relating to asset building and banking the underbanked, in which context the importance of consumer protection, for both credit and other products, is plainly apparent. Finally, my years at Fannie Mae and at ShoreBank and the community development work I have been doing have made me both conscious of and extremely sad about what has happened in the mortgage market and the effects it is having on both households and communities. Based on my OTS experience, I believe the bank regulators, given the proper guidance from Congress and the will to act, are fully capable of effectively enforcing consumer protection laws. Moreover, because of the system of prudential supervision, with its onsite examinations, they are also in an extremely good position to do so and to do it in a manner that benefits both consumers and the safety and soundness of the regulated institutions. In three particular cases during my OTS tenure, concern about consumer issues led directly to safety and soundness improvements. Two involved guidance that got thrifts out of sub-prime monoline credit card lending (just months before that industry got into serious trouble) and payday lending. In another case involving a specific institution, through our compliance examiners' concern about bad credit card practices, we uncovered serious fair lending and safety and soundness issues. Consumer protection can be the canary that gives early warning of safety and soundness issues--but only if someone is paying attention to dying birds. We also sounded the alarm on predatory lending. Sub-prime guidance issued in 1998 by all the bank regulators warned of both safety and soundness and consumer protection issues. In speeches and testimony I gave in 2000, concerns about predatory lending and discussion about what we were doing to respond were a consistent theme. Nevertheless, as I will discuss below, I think it is time to consider whether consolidation of both the function of writing regulations and the receipt of complaints would make the system more effective for consumers, for financial institutions and for the economy.The Current Crisis The current crisis has many causes, including an over-reliance on finance to ``solve'' many of the needs of our citizens. When real incomes stagnate while the cost of housing, health care and education skyrocket, there are really only two possible results: people do without or they become more and more overleveraged. Financial engineering and cheap investor funding, largely from abroad, enabled the overleveraging, but a lack of adequate attention to the manner in which the financial services system interacted with consumers certainly kept the process going and caused consumers and the economy to fall harder when it ended. There were really two parallel problems: the proliferation of bad products and practices and the sale of hard-to-understand credit and investment products to consumers for whom they were not suitable; and the lack of high quality products that meet consumer needs, well priced and effectively marketed, especially in lower income communities. I believe that there where three basic regulatory problems. First, there was a lack of attention, and sometimes unwillingness, to effectively regulate products and practices even where regulatory authority existed. The clearest example of this is the Federal Reserve's unwillingness to regulate mortgage lending under HOEPA. However, as the recent actions by the Federal Reserve, OTS and NCUA have demonstrated, there was also authority under the FTC Act that went unused. It is important to understand that this is not only an issue of not issuing regulations or guidance; it is perhaps even more importantly a lack of effective enforcement. Compliance has always had a hard time competing with safety and soundness for the attention of regulators--which is one reason I spent a good deal of my tenure at OTS emphasizing its importance--but there was a deliberate downgrading of the compliance function at the Federal level at the start of the Bush Administration. Moreover, neither the Federal Reserve nor the OTS--at least until fairly recently--has seriously probed the consumer practices of non-depository subsidiaries of the holding companies they regulate. This is not just an issue at the Federal level. While there are certain states--North Carolina, Maryland and Massachusetts prominent among them--that have consistently engaged in effective enforcement of consumer protection laws with respect to the entities under their regulation, others, including California, the home of many of the most aggressive mortgage lenders, were even less aggressive than the Federal regulators. Moreover, ineffective enforcement is not just an issue of consumer protection regulation per se; the ability to move badly underwritten products completely off the balance sheet, earning fees for originating them, but holding no responsibility for them and no capital against them, only encouraged the proliferation of such activities. Second, we need to acknowledge that there were, and are, holes in the regulatory system, both in terms of unregulated entities and products, and in terms of insufficient statutory authority. The clearest case relates to mortgage brokers, where there was no Federal regulation at all, no regulation beyond simple registration in many states, and ineffective regulation even in most of the states that actually asserted some regulatory authority. But there are other examples--payday lending is prohibited in some states, regulated more or less effectively in others, and pretty much allowed without restriction in still others. And then of course there is the question of what kind of responsibility sellers of non-investment financial products have to customers. We know we have not imposed a fiduciary duty on them, but does that mean there is no responsibility to match customer with product? Finally, there is and was confusion, for both the regulated entities and consumers and those who work with them. Consumer protection comes in many forms, from substantive prohibitions like usury ceilings and payday lending prohibitions, through required terms and practices, to disclosures and marketing rules. I would assert it also includes the affirmative mandate of the Community Reinvestment Act; recent experience has demonstrated that where well-regulated entities do not provide quality services that meet needs and are well marketed, expensive and sometimes predatory substitutes will move in. Multiple regulators and enforcement channels exacerbate the confusion. At the Federal level, there are multiple bank regulators, not to mention the NCUA, the FTC and HUD, and their jurisdiction is frequently overlapping. States and even localities also regulate consumer protection, again often through multiple agencies. And of course, sometimes the Federal and State laws overlap. The enforcement mechanisms are just as confusing, involving examinations, complaints, collateral consequences such as limitations on municipal deposits or procurement, and both public and private lawsuits. The system clearly could be improved. But as we do so, we should not be lulled into thing the solutions are obvious or easy. In general they're not, and I would assert that they are harder and more subtle than is the case with manufactured consumer products. The products, even the good ones, can be extremely complex. Just try describing the lifetime interest rate on a Savings Bond or how a capped ARM works. Or for that matter whether a payday loan or a bounced check is more expensive. Many products, especially loans and investments, involve both uncertainty and difficult math over a long period of time, which is hard for even the most educated consumer. And the differences between a good product and a bad one can be subtle, especially if the consumer doesn't know where to look. An experienced homeowner knows the importance of escrowing insurance and taxes, but the dire consequences of the lack of an escrow are easy for a first-time homebuyer to miss. And a relatively safe ARM can turn into a risky one when caps are removed or a prepayment penalty added. Finally, different consumers legitimately have different needs. To take the example economists love, when there is a normal, upward sloping yield curve, most homebuyers are better off with a 5-year ARM than with a 30-year fixed rate mortgage, because with the long-term loan they are paying a higher interest rate for an option they are unlikely ever to use, since they will likely move, prepay or refinance long before 30 years are up. But for a consumer whose income is unlikely to increase, who has few other resources, or who has difficulty budgeting--or who is just plain risk-averse--the certainty of the fixed rate mortgage may well be worth the additional cost.Looking Forward Before turning to regulatory issues, I suggest there is a broader social context of change that we need to consider. To what extent can we turn some of the complex, long-term financial obligations that we have foisted on individual consumers--most clearly retirement and health care--back to more collective management? We also should recognize that there is some level of interest and some level of financial engineering at which ``availability of credit'' is an excuse for both not having sufficient income and collateral supports (such as health care) and an insufficient level of financial understanding--it's not a way of life. We need to educate our children from day one about what money means, how interest rates work, and who to get help from, and we need to create systems of helpers, which can include the internet and things like overdraft alarms, but which also requires low-cost access to people who are competent to give advice and have a fiduciary duty to the consumer. In this period when consumers are being forced to deleverage and cut back, and are actually beginning to save more on their own accord, we should once again make saving easy and an expected part of life. Having an account at a bank or credit union helps encourage saving, although the account needs to be designed so consumers have the liquidity they need without paying for it through excessive overdraft fees. Tying savings to credit, such as by requiring part of a mortgage payment to go into a savings account for emergencies like repairs or temporary inability to make a payment, can also help. And so would moving toward more savings opt-outs, like payroll deductions for non-restricted savings accounts that can be used in an emergency (as well as for retirement accounts), a concept we are testing at the New America Foundation as AutoSave.Principles for Regulation The regulatory framework, of course, involves both how to regulate and who does it. With respect to how, I suggest three guiding principles. First, to the maximum extent possible, products that perform similar functions should be regulated similarly, no matter what they are called or what kind of entity sells them. For example, we know that many people regarded money market mutual funds and federally insured deposit accounts as interchangeable. Either they are, and both the products and--to the extent the regulation has to do with making sure the money is there when the customer wants it--the regulation should be similar, or they are not and they should not be treated as such, including by regulators who are assessing capital requirements. To take another example, payday loans and bounced check protection have a good deal in common, and probably should be regulated in a similar manner. This also means that a mortgage sold directly through a bank should be subject to the same regulatory scheme and requirements as one sold through a broker. Second, we should stop relying on consumer disclosure as the primary method of protecting consumers. While such disclosures can be helpful, they are least helpful where they are needed the most, when products and features are complex. The Federal Reserve's recognition of this with respect to double cycle credit card billing was a critical breakthrough: by working with consumers, they came to understand that no amount of disclosure was going to enable consumers to understand the practice. The same is true of very complex mortgage products. The ``one page disclosure'' is great for simple mortgage products, but where there are multiple difficult-to-understand concepts in a single mortgage--indexes and margins, caps on rate increases and on payments, per adjustment and over the loan's lifetime, escrows or not, prepayment penalties that change over time, option payments and negative amortization, and many different fees--the likelihood is low that any disclosure will enable those for whom these issues really make a difference to understand them. In the last few years, several academics have suggested some potential substitutes for disclosure that go beyond the traditional type of prohibitory consumer protection rules. For example, Professor Ronald Mann has suggested that credit card contracts be standardized, with competition allowed on only a few easily understood terms, such as annual fees and interest rates.\1\ In some ways, this is what the situation was with mortgages well into the 1990s. Professors Michael Barr, Eldar Shafir and Sendil Mullainathan have suggested the development of high quality, easily understood ``default'' products such as mortgages, credit cards and bank accounts, allowing other products to be sold, but with more negative consequences for sellers if the products go bad, such as requiring the seller to prove that the disclosures were reasonable as a condition to enforcing the contract, including in a mortgage foreclosure action.\2\--------------------------------------------------------------------------- \1\ Ronald Mann, `` `Contracting' for Credit,'' 104 Mich LR 899 (2006) at 927-28. \2\ Michael Barr, Sendhil Mullainathan, and Eldar Shafir, ``A One-Size-Fits-All Solution,'' New York Times, December 26, 2007, available at http://www.nytimes.com/2007/12/26/opinion/26barr.html?scp=1&sq=michael percent20barr percent20mortgage&st=cse. See also Michael Barr, Sendhil Mullainathan, and Eldar Shafir, ``Behaviorally Informed Financial Services Regulation'' (Washington, DC: New America Foundation, October 2008), available at http://www.newamerica.net/files/naf_behavioral_v5.pdf. --------------------------------------------------------------------------- Third, enforcement is at least as important as writing the rules. Rules that are not enforced, or not enforced equally across providers, generate both false comfort and confusion, and tend to drive, through market forces, all providers to the practices of the least well regulated. This is in many ways what we have seen with respect to mortgages; it is not just that some entities were not subject to the same rules as others, but also that the rules were not enforced consistently across entities.Who Should Regulate As discussed above, that there are currently a myriad of regulators both making the rules and enforcing them. This situation makes accomplishment of the substantive principles discussed above very difficult. To a substantial extent, both the Federal Reserve and the FTC have broad jurisdiction already; whether they take action to write rules depends to some extent on capacity, will and priorities. But even where they have such authority and take it, significant problems remain concerning both enforcement and to what extent their rules trump State rules. The bank regulators, both together when they can agree and separately when they can't, also write rules and guidance that is often as effective as rules, but those apply only to entities under their jurisdiction, and generate very substantial controversy concerning the extent to which regulations of the OCC and OTS preempt State laws and regulations. As I mentioned at the start, I believe the bank regulators, given the guidance from Congress to elevate consumer protection to the same level of concern as safety and soundness, can be highly effective in enforcing consumer protection laws. Nevertheless, I think it is time to give consideration to unifying the writing of regulations as to major consumer financial products--starting with credit products--and also to establish a single national repository for the receipt of consumer complaints. The mortgage situation has shown that a single set of regulations that governs all parties is a precondition to keeping the market at the level of those engaged in best practices--or at least the practices condoned by the regulators--not the worst. The situation with payday lending, especially in multi-State metropolitan areas, is similar. And among regulators with similar jurisdictions, whether the Federal bank regulators or State regulators, having major consumer products governed by a single set of regulations will reduce the opportunity for regulatory arbitrage. A single entity dedicated to the development of consumer protection regulations, if properly funded and staffed--unfortunately the experience of both the FTC and CPSC over the last 8 years, but in fact for many more years suggests that's a big ``if''--will be more likely to focus on problems that are developing and to propose, and potentially, take action before they get out of hand. In addition, centralizing the complaint function in such an entity will give consumers and those who work with them a single point of contact and the regulatory body the early warning of trouble that consumer complaints provide. Such a body will also have the opportunity to become expert in consumer understanding and behavior. This will enable it to use the theories and practices being developed about consumer understanding and how to maximize positive consumer behavior--the learnings of behavioral economics--to regulate effectively without necessarily having a heavy hand. The regulator could also become the focus for the myriad of scattered and inefficient Federal efforts surrounding financial education. The single regulator concept is not, however, a panacea. Three major issues that could stymie such a regulator's effectiveness are funding, preemption, and the extent of its enforcement authority. How will the new regulator be funded, and at what level? It is tempting to think that annual appropriations will be sufficient, but is that really the case? Political winds and priorities change, and experience suggests that consumer regulatory agencies are at risk of reduced funding. Is this a place for user fees--a prospect more palatable if there is a single regulator covering all those in the business rather than multiple regulatory bodies for whom lower fees can become a marketing tool? In any event, it is essential that this entity be well funded; if it is not, it will do more harm than good, as those relying on it will not be able to count on its being effective. What will be the regulator's enforcement authority? Will it have primary authority over any group of entities? Will the authority be secondary to other regulatory bodies that license or charter those providing financial services? My opinion is that regulators who engage in prudential supervision (Federal and State), with onsite examinations, should have primary regulatory authority, with the new entity empowered to bring an enforcement action if it believes the regulations are not being effectively enforced. Coupled with Congressional direction to the prudential supervisors to place additional emphasis on consumer protection, the supplemental authority of the consumer protection regulator to act should limit the number of situations in which the new regulator is forced to take action. And finally, will the regulations written by the new entity preempt both regulations and guidance of other Federal regulators and State regulation? My opinion is that where the new entity acts, their regulations should be preemptive. We have a single national marketplace for most consumer financial products. Whereas in the past the argument that providers can't be expected to respond to a myriad of rules held sway, as technology has advanced this argument has lost its potency. But consumers are entitled to a consistent level of protection no matter where they live and with whom they deal. Yes, there may be times when the agency does not work as fast or as broadly as some advocates would like. But the point of having a single agency with responsibility in this area is to create a single focal point for action that will benefit all Americans. Where the agency does take action, it should fill the field. But preemption may well be the most difficult issue of all, not only because preemption is ideologically difficult, but also because the uniformity that a single regulator can provide will always be in tension with the attempts of some actors to get around the regulations and of regulators and other parties to move in to respond.Conclusion While the current crisis has many causes, the triggering event was almost certainly the collapse of the sub-prime mortgage market. That is an event that need never have happened if both our regulatory system and regulators had been more completely and effectively focused on protecting consumers. For many years, many of us have been pointing out that bad consumer practices are also bad economic practices. Not only because of the damage it does to consumers, but also because when the music stops, we all get hurt. The current state of affairs provides a golden opportunity to make significant improvements in the regulatory system. If not now, when? ______ CHRG-110hhrg46596--64 Mr. Kashkari," Good morning, Mr. Chairman, Ranking Member Bachus, and members of the committee. Thank you for asking me to testify before you today regarding oversight of the Troubled Asset Relief Program. We are in an unprecedented period, and market events are moving rapidly and unpredictably. We at Treasury have responded quickly to adapt to events on the ground. Throughout the crisis, we have always acted with the following critical objectives: One, to stabilize financial markets and reduce systemic risk; two, to support the housing market by avoiding preventable foreclosures and supporting mortgage finance; and three, to protect the taxpayers. The authority and the flexibility granted to us by the Congress has been essential to developing the programs necessary to meet those objectives. Today, I will describe the many steps we are taking to ensure compliance with both the letter and the spirit of the law and what measurements we look at to gauge our success. A program as large and complex as the TARP would normally take many months or years to establish. Given the severity of the financial crisis, we must build the Office of Financial Stability, we must design our programs, and we must execute our programs all at the same time. We have made remarkable progress since the President signed the law only 68 days ago. The first topic I will address is oversight of the TARP. We first moved immediately to establish the Financial Stability Oversight Board. The board has already met 5 times in the 2 months since the law was signed, with numerous staff calls between meetings. We have also posted bylaws and minutes from those board meetings on the Treasury Web site. Second, the law requires an appointment of a Senate-confirmed special inspector general to oversee the program. We welcome the Senate's confirmation, just on Monday, of Mr. Barofsky as special IG. I spoke with him just yesterday, and we look forward to working closely with his office. In the interim, pending his confirmation, we have been coordinating closely with the Treasury's inspector general. We have had numerous meetings with Treasury's Inspector General to keep them apprised of all TARP activity. And we look forward to continuing our active dialogue with both the Treasury IG and the special IG as he builds up his office. Third, the law calls for the GAO to establish a physical presence at Treasury to monitor the program. We have had numerous briefings with GAO, and our respective staffs meet or speak on an almost daily basis to update them on the program and review contracts. The GAO published its first report on the TARP, as Mr. Dodaro said, on December 2nd. They provided a thorough review of the TARP program and progress to date, essentially a snapshot in time at the 60-day mark of a large, complex project that continues to be a successful work in progress. We are pleased with our auditors' recommendations, because the GAO has identified topics that we are already focused on. The report was quite helpful to us because it provided us with thoughtful, independent verification that we are, indeed, focused in the right topics. And we agree with the GAO on the importance of these issues. Our work continues. Finally, the law called for the establishment of a congressional oversight panel, the fourth oversight body to review the TARP. That oversight panel was recently formed, and we had our first meeting with them on Friday, November 21st. We look forward to having additional meetings with the congressional oversight panel. Now, people often ask, how do we know our programs are working? First, and this is very important, we did not allow the financial system to collapse. That is the most important information that we have. Second, the system is fundamentally more stable than it was when Congress passed the legislation. While it is difficult to isolate one program's effects, given the numerous steps that policymakers have taken, one indicator that points to reduced risk among default of financial institutions is the average credit default swap spread for the eight largest U.S. banks. That CDS spread has declined 200 basis points since before Congress passed the law. Another key indicator of perceived risk in the financial system is the spread between LIBOR and OIS. The 1-month and 3-month LIBOR-OIS spreads have each declined 100 basis points since the law was signed and 180 basis points from their peak before the CPP was announced on October 14th. People also ask, when will we see banks making new loans? First, we must remember that just over half the money allocated to the Capital Purchase Program is out the door. Although we are executing at report speed, it will still take a few months to process all of the remaining applications. The money needs to get into the system before it can have the desired effect. Second, we are still at a point of low confidence, both due to the financial crisis and due to the economic downturn. As long as confidence remains low, banks will remain cautious about extending credit, and consumers and businesses will remain cautious about taking on new loans themselves. As confidence returns, we expect to see more credit extended. We are actively engaged with regulators to determine the best way to monitor these capital investments in bank lending. We may utilize a variety of supervisory information for insured depositories, including the Home Mortgage Disclosure Act data, the Community Reinvestment Act data, call report data, examination information contained in CRA public evaluations, as well as broader financial data and conditions. In conclusion, while we have made significant progress, we recognize that challenges lie ahead. As Secretary Paulson has said, there is no single action the Federal Government can take to end the financial market turmoil or the economic downturn, but the new authorities that you provided, you and your colleagues provided in October, dramatically expanded the tools available to address the needs of our system. We are confident we are pursuing the right strategy to stabilize the financial system and support the flow of credit to the economy. Thank you again for having me here today, and I would be happy to take your questions. [The prepared statement of Mr. Kashkari can be found on page 115 of the appendix.] " fcic_final_report_full--441 TWO TYPES OF SYSTEMIC FAILURE Government policymakers were afraid of large firms’ sudden and disorderly failure and chose to intervene as a result. At times, intervention itself contributed to fear and uncertainty about the stability of the financial system. These interventions responded to two types of systemic failure. Systemic failure type one: contagion We begin by defining contagion and too big to fail . If financial firm X is a large counterparty to other firms, X’s sudden and disorderly bankruptcy might weaken the finances of those other firms and cause them to fail. We call this the risk of contagion , when, because of a direct financial link between firms, the failure of one causes the failure of another. Financial firm X is too big to fail if policymakers fear contagion so much that they are unwilling to allow it to go bankrupt in a sudden and disorderly fashion. Policymakers make this judgment in large part based on how much counterparty risk other firms have to the failing firm, along with a judgment about the likelihood and possible damage of contagion. Policymakers may also act if they worry about the effects of a failed firm on a par- ticular financial market in which that firm is a large participant. The determination of too big to fail rests in the minds of the policymakers who must decide whether to “bail out” a failing firm. They may be more likely to act if they are uncertain about the size of counterparty credit risk or about the health of an important financial market, or if broader market or economic conditions make them more risk averse. This logic can explain the actions of policymakers  in several cases in : • In March, the Fed facilitated JPMorgan’s purchase of Bear Stearns by providing a bridge loan and loss protection on a pool of Bear’s assets. While policymakers were concerned about the failure of Bear Stearns itself and its direct effects on other firms, their decision to act was heightened by their uncertainty about po- tential broader market instability and the potential impact of Bear Stearns’ sud- den failure on the tri-party repo market. • In September, the Federal Housing Finance Agency (FHFA) put Fannie Mae and Freddie Mac into conservatorship. Policymakers in effect promised that “the line would be drawn between debt and equity,” such that equity holders were wiped out but GSE debt would be worth  cents on the dollar. They made this decision because banking regulators (and others) treated Fannie and Freddie debt as equivalent to Treasuries. A bank cannot hold all of its assets in debt issued by General Electric or AT&T, but can hold it all in Fannie or Fred- die debt. The same is true for many other investors in the United States and around the world–they assumed that GSE debt was perfectly safe and so they weighted it too heavily in their portfolios. Policymakers were convinced that this counterparty risk faced by many financial institutions meant that any write-down of GSE debt would trigger a chain of failures throughout the finan- cial system. In addition, GSE debt was used as collateral in short-term lending markets, and by extension, their failure would have led to a sudden massive contraction of credit beyond what did occur. Finally, mortgage markets de- pended so heavily on the GSEs for securitization that policymakers concluded that their sudden failure would effectively halt the creation of new mortgages. All three reasons led policymakers to conclude that Fannie Mae and Freddie Mac were too big to fail. • In September, the Federal Reserve, with support from Treasury, “bailed out” AIG, preventing it from sudden disorderly failure. They took this action because AIG was a huge seller of credit default swaps to a number of large financial firms, and they were concerned that an AIG default would trigger mandatory write-downs on those firms’ balance sheets, forcing counterparties to scramble to replace hedges in a distressed market and potentially triggering a cascade of failures. AIG also had important lines of business in insuring consumer and business activities that would have been threatened by a failure of AIG’s financial products division and potentially led to severe shocks to business and consumer confidence. The decision to aid AIG was also influenced by the extremely stressed market conditions resulting from other institutional failures in prior days and weeks. • In November, the Federal Reserve, FDIC, and Treasury provided assistance to Citigroup. Regulators feared that the failure of Citigroup, one of the nation’s largest banks, would both undermine confidence the financial system gained after TARP and potentially lead to the failures of Citi’s major counterparties. CHRG-110hhrg38392--153 Mr. Lynch," Thank you, Mr. Chairman. I will try to be brief. I do want to go back to an issue that Mr. Royce and others have talked about, the subprime mortgage problems that we have been having. In your own remarks, Mr. Chairman, you mentioned that the subprime mortgage sector has deteriorated significantly, the conditions there, and that reflecting mounting delinquency rates on adjustable rate loans continue to be a growing problem. You also note that one risk to the economic outcome is that the ongoing housing correction might indeed prove larger than originally anticipated with possible spillovers into the consumer spending area. And in addition, you made remarks that the recent rabid expansion of the subprime market was clearly accompanied by deterioration underwriting standards, and in some cases, by abusive lending practices and outright fraud. And while we all agree that promoting access, as you have noted, to credit and to homeownership are important objectives, we do, in my opinion, need to do something more concrete, not only going forward. And I appreciate that I know you worked with some other Federal supervisory agencies to issue a principles-based guidance and nontraditional mortgage regulation, and that in June, you issued a supervisory guidance on subprime lending going forward. But I do want to note that in Massachusetts, this is just one example that I throw out there, Governor Deval Patrick instituted a moratorium working with mortgage lenders in Massachusetts, instituted a moratorium on foreclosures and a coordinated workout process for some of those folks that were harmed because of the, as you have noted, abusive lending practices and in some cases outright fraud. And I was wondering, is there anything--it is sort of a two-part question. One, are we doing anything going forward more significantly and more specific than described in your general guidance, and are we looking at all at possibilities working--I know you are working with the States--are we looking at any ways to maybe hold those people harmless or to mitigate the damage that might have been done because of abusive lending practices or that fraud? " FOMC20080121confcall--19 17,MR. ROSENGREN.," I, too, strongly support reducing the federal funds rate 75 basis points. I am very concerned about financial market conditions detailed earlier by Bill. It is widely viewed in the business community that we are slipping into a recession. Problems with consumer debt are growing. I am concerned not only that we might be in, or about to be in, a recession. I am concerned also how severe a recession could be. It is time to take decisive and aggressive action, and I agree that, even with this cut, downside risks remain. Thank you. " CHRG-111hhrg51698--89 Mr. Kagen," But coming back to the point that was made by Mr. Gooch, and that was that the mortgages have failed and not the CDSs, it is just the opposite, because the notional value that is a result of the CDS activity is far, far greater, perhaps to the tune of $50 trillion greater, than the underlying assets of the mortgages in the paper. I see my time has expired, and I apologize for going over if I have. But, Mr. Gooch, if you would like to make a comment, do you stand by your statement that it was the mortgages that have failed that have helped to create this illiquid condition throughout the global marketplace and not the derivatives markets? " CHRG-111shrg50815--11 Mr. Levitin," Good morning, Mr. Chairman, Ranking Member Shelby, and members of the Committee. I am pleased to testify today in support of the Chairman's Credit Card Accountability, Responsibility, and Disclosure Act and other legislation that would create a more efficient and fair credit card market and would encourage greater consumer responsibility in the use of credit. Credit cards are an important financial product. They offer many benefits and conveniences to consumers. But credit cards are also much more complicated than any other consumer financial product, and unnecessarily so. Auto loans, student loans, closed-end bank loans, and all but the most exotic mortgages are relatively simple. They have one or two price terms that are fixed or vary according to an index. Not so with credit cards. Credit cards have annual fees, merchant fees, teaser interest rates, purchase interest rates, balance transfer interest rates, cash advance interest rates, overdraft advance interest rates, default or penalty interest rates, late fees, over-limit fees, balance transfer fees, cash advance fees, international transaction fees, telephone payment fees, and probably several other fees of which I am unaware. In addition to these explicit price points, there are also numerous hidden fees in the form of credit card billing practices. The card industry has been ingenious in creating tricks and traps to squeeze extra revenue out of unsuspecting consumers. These billing tricks cost American families over $12 billion a year. Credit card billing tricks make cards appear to be much cheaper than they actually are, and that leads consumers to use cards too much and to use the wrong cards. By disguising the cost of using cards through billing practices, card issuers are able to maintain uncompetitively high interest rates and to generate greater use of cards. That produces additional revenue from interchange fees for the issuers as well as over-limit fees, late fees, and penalty fee revenue. The complexity of credit card pricing makes it impossible for consumers to accurately gauge the price of any particular credit card, and unless consumers can gauge the cost of using a card, they cannot use it efficiently and responsibly. Markets cannot function without transparent pricing because demand is a function of price. The lack of transparency in credit card pricing has resulted in inefficient and irresponsible use of credit, and that has resulted in dangerously over-leveraged consumers, who are paying too much for what should be a commodity product with razor-thin profit margins rather than one with a return on assets that is several multiples of other banking activities. Consumer over-leverage is a factor that should concern all of us, especially today. There is nearly a trillion dollars of credit card debt outstanding. The average carded household owed almost $11,000 in credit card debt last year. That is a drop in the bucket compared with household mortgage debt, but even the most exorbitant subprime mortgage rate is rarely over 10 percent annually, whereas the effective APR on many credit cards--the effective APR--can easily be five times as high. And the harm to families is palpable. A single repricing due to a billing trick can cost a family between an eighth and a quarter of its discretionary income. These levels of credit card debt are not sustainable. Dollar for dollar, a consumer with credit card debt is more likely to file for bankruptcy than a consumer with any other type of debt. And to the extent that consumers are servicing high-interest-rate credit card debt, that is money they cannot use to purchase new goods and services from merchants. The money siphoned off by credit card billing practices does not create value. It cannot be spent in the real economy. The card industry's arguments that Congress should not interfere with their finely calibrated risk-based pricing are malarkey. Only a very small component of credit card pricing reflects risk. Almost all credit card pricing is a function of the cost of funds, the cost of operations, and the ability-to-opportunity price, not the function of risk. Moreover, to the extent that credit card prices reflect a risk premium, it is a pool-based premium. It is not an individualized risk premium. The card industry is not capable of pricing for risk on an individual basis. The technology is not there. This means that there is inevitably subsidization of riskier consumers by more creditworthy ones. Nor is there any evidence that connects the so-called risk-based pricing to lower costs of credit for creditworthy consumers. While it is true that base interest rates have fallen, that is almost entirely a function of the lower cost of funds, and the decline in base interest rates has been offset by increases in other credit card prices. According to the GAO, for 1990 to 2005, late fees have risen an average of 160 percent, and over-limit fees have risen an average of 115 percent. Since the 1990s, credit card pricing has been a game of three-card monte. Pricing has been shifted away from the up-front, attention grabbing price points, like annual fees and base interest rates, and shifted to back-end fees that consumers are likely to ignore or underestimate. The card industry's risk-based pricing story simply doesn't hold up on the evidence and is not a reason to refrain from much-needed regulation of unfair and abusive credit card billing and pricing practices that have had a deleterious impact on the economy and society. Legislation like the Credit Card Accountability, Responsibility, and Disclosure Act is a crucial step in restoring transparency and fairness to the credit card market and to letting American consumers responsibly enjoy the benefits of credit cards. Thank you. Senator Johnson. Thank you, Mr. Levitin. The panel should know that we will limit your remarks to 5 minutes in order to have a proper question and answer period. Mr. Clayton? STATEMENT OF KENNETH J. CLAYTON, SENIOR VICE PRESIDENT AND FinancialCrisisReport--92 WaMu did, at times, exercise oversight of its third party brokers. A 2006 credit review of its subprime loans, for example, showed that Long Beach – which by then reported to the WaMu Home Loans Division – had terminated relationships with ten brokers in 2006, primarily because their loans had experienced high rates of first payment defaults requiring Long Beach to repurchase them at significant expense. 292 But terminating those ten brokers was not enough to cure the many problems with the third party loans WaMu acquired. The report also noted that, in 2006, apparently for the first time, Long Beach had introduced “collateral and broker risk” into its underwriting process. 293 WaMu closed down its wholesale and subprime channels in 2007, and its Alt A and subprime securitization conduits in 2008. (b) Risk Layering During the five-year period reviewed by the Subcommittee, from 2004 to 2008, WaMu issued many loans with multiple higher risk features, a practice known as “risk layering.” At the April 13 Subcommittee hearing, Mr. Vanasek, its Chief Risk Officer from 2004 to 2005, testified about the dangers of this practice: “It was the layering of risk brought about by these incremental changes that so altered the underlying credit quality of mortgage lending which became painfully evident once housing prices peaked and began to decline. Some may characterize the events that took place as a ‘perfect storm,’ but I would describe it as an inevitable consequence of consistently adding risk to the portfolio in a period of inflated housing price appreciation.” 294 Stated Income Loans. One common risk layering practice at WaMu was to allow borrowers to “state” the amount of their annual income in their loan applications without any direct documentation or verification by the bank. Data compiled by the Treasury and the FDIC IG report showed that, by the end of 2007, 50% of WaMu’s subprime loans, 73% of its Option ARMs, and 90% of its home equity loans were stated income loans. 295 The bank’s acceptance of unverified income information came on top of its use of loans with other high risk features, such 291 Id. at 58615. 292 12/2006 “Home Loans – SubPrime Quarterly Credit Risk Review,” JPM_WM04107374, Hearing Exhibit 4/13- 14. 293 Id. at JPM_WM04107375. 294 April 13, 2010 Subcommittee Hearing at 16. 295 4/2010 IG Report, at 10, Hearing Exhibit 4/16-82. as borrowers with low credit scores or the use of low initial teaser interest rates followed by much higher rates. FOMC20081216meeting--298 296,MR. KOHN.," Thank you, Mr. Chairman. Like the others who have spoken before me, I think this situation is very serious. We need to do all we can, and I think we need to recognize the reality of where we are. So either alternative A or alternative B does that to a significant extent. I guess I have a slight preference for alternative A as a better recognition that we are not really controlling the federal funds rate in here. We have these other balance sheet things going on, and to me alternative B has a little of the flavor of drawing your target around the hole we have already made in the barn door, or whatever, and pretending that you have some control that you don't really have. So I think A is better. President Bullard made a very good point that A tends to refocus attention on these alternative policies that we all agree will be the focus of our attention going forward. But I could live with either A or B. In terms of some of the issues you raised--so going down alternative A--in paragraph 2, the bracketed language, here I agree with President Lacker. I think my slight preference would be to wait until January to do this. Whether or not we have an explicit inflation target as we come out of the January meeting, we can debate in January. We will, I hope, have at least these long-run projections, and this bracketed language can be explained in terms of those long-run projections. Right now, it kind of sits out there. We haven't yet explained what we think the rates are that best foster economic growth and price stability in the longer term. By the end of the January meeting, we can do that. So I think I would wait for that. I think the conditional language in the third paragraph is helpful, and I would favor keeping it in. It is appropriately conditioned on weak economic conditions. If other people wanted to add ""the disinflationary forces,"" which I think come primarily from the weak economic conditions, that would be okay with me, too. But I am fine with this. In the first sentence of paragraph 4--this is a small point--I would take out the ""to continue"": ""The focus of policy going forward will be to support the functioning . . .."" When I first read the ""to continue,"" it sounded as though we are just going to continue what we are doing now. So I would take that out, but that is a small point. On the discussion about whether we should put the size in, I am a little worried about putting it in because the balance sheet has grown so rapidly. If it came down because year-end pressures abated and because the swaps with all of those foreign central banks might tend to come down after the end of the year, I don't think that the Committee would necessarily want Bill to be replacing every dollar of Eurodollar swaps that came down with something else. I think we are talking about a long-run trend in the base, and we need to be careful about not trying to leave the impression that in every intermeeting period we would expect the base to increase, especially when we don't control that size. So I would be a little cautious about that. Certainly, if we did include ""increase the size of the balance sheet,"" I also would say something about the composition. In my view, it is actually the composition more than the size that is going to influence relative asset prices, even though I do recognize that over very long periods, if we keep the base from declining, it would be hard to have prices decline. But I am not sure that is really an effective way to deal with expectations in the short or intermediate run. I would include the purchases of longer-term Treasury securities. Among other things, I think we ought to do it sometime in the next few months. The fact that you have already talked about it, if we omit it--I guess I disagree with President Evans here--I don't think that will be low cost. We have a series of things we are doing, and that is not part of it. I think there could be an adverse market reaction. Going back to the base for a second, I agree that we need to do a better job of explaining, as I said yesterday, what this new framework is, how the increase in reserves and the base fits into it--if we can come to some conclusion on that--and why under these circumstances a very large increase in the base isn't inflationary and how that comes about. We need to do a much better job of explaining these kinds of things. But, again, I would be hesitant to put an explicit target in terms of the level of reserves or the base in there because I don't really understand the channels through which they influence prices or activity in the short and intermediate terms. Finally, on bank profits and the effects there, ordinarily I wouldn't worry about bank profits. It is just a transfer between the owners of banks and households and businesses, and quite frankly, transferring some income to households and businesses seems like a pretty good idea most of the time in these circumstances. I agree that it is more ambiguous than usual, given the worries about the financial sector. Still, we are doing a lot for the banks. We are giving them capital. We are guaranteeing their liabilities--we, the government, that is. This will reduce the rates at which they borrow from the discount window and from each other, so they are getting something there. I think banks are going to need to figure out how to operate at these really low interest rates, so I wouldn't let my concern about bank profits stop me from doing either alternative A or alternative B. Thank you, Mr. Chairman. " CHRG-110hhrg46593--17 The Chairman," Thank you. Before I begin my questioning, I want to just put into the record: A very thoughtful letter from our colleague Mr. Kucinich, who was chair of a Subcommittee on Government Reform, strongly arguing for help on foreclosures; a letter that was sent to me and a letter was also sent to the Secretary from Michael Fryzel, the Presidential appointee to head the National Credit Union Administration, objecting strenuously on behalf of the health of the credit union industry to the decision not to buy up any assets; and also, a statement from the National Association of Realtors. I will now begin my 5 minutes, and I am going to hold everybody to the 5 minutes. First, I welcome the two Chairs to the interagency statement on meeting the needs of creditworthy borrowers. It is a very good statement. It will be an even better statement if somebody gets whacked for not following it. There has to be some teeth. And it does talk about compensation, about dividends, and it is a very good statement. I can't imagine that a month from now everybody will have complied, and so, therefore, frankly, evidence that it meant something will be if there were at least some letters issued or some penalties. Secondly, I just want to report on the oversight board, and the gentleman from Texas referred to it. My understanding is that the Senate Majority Leader and the Speaker have appointed their members. The minority leaders have not appointed their members yet, so the board is not yet functional. Earlier this week, or last week, three members were appointed, as called for under the statute, by the Majority Leader of the Senate and the Speaker. Now I want to get to the issue of mortgage foreclosure. First, Mr. Secretary, I am going to also put into the record a 4-page memo of sections of the law that we passed which mandate that if you buy assets, you do mortgage foreclosure. And make it very clear, when you say spending--first, I have to say this: We obviously all appreciate the concern for the taxpayers' money. But the Chair of the FDIC talks about $24 billion. That is, what, 40 percent of what we just gave to AIG out of this program. And you say this is for an investment and not spending. I don't know what investment counselor, absent macro economics conditions, would have advised you to invest in AIG. I suspect it does not rate highly as an investment these days. I hope it goes well going forward. And there is no question that this will be helpful to it. But $40 billion for AIG, and then we can't find $24 billion on the mortgage foreclosure, is part of the reason we have the real problem with the country. But let me just say, it is 4 pages of specific authorization to buy up mortgages and write them down. Section 109(c): ``Upon any request arising under existing investment contracts, the Secretary shall consent, where appropriate in considering net present value to the taxpayer, to reasonable requests for lost mitigation measures.'' In section 110, homeowner assistance by agencies: ``To the extent that the Federal property manager holds onto, controls mortgages, they shall implement a plan that seeks to maximize assistance for homeowners.'' The bill is replete with authorization to you not simply to buy up mortgages but in effect to do some spending because we are talking about writing them down. So the argument that--frankly, of all the changes that have come in the program, this wouldn't be a change. This was the program. And my colleague from California, whom you will be hearing from shortly, made a big point of this on the Floor. So the argument that this is not part of the program simply doesn't work. Would you agree, Mr. Secretary, that in fact the bill does authorize aggressive action not simply to buy up mortgages but, in buying them up, take some action to reduce in some ways the amount owed so we diminish foreclosures? " FOMC20060629meeting--50 48,MR. STOCKTON.," It’s a big revision, and as you can imagine, we agonized a lot about “isn’t this is a big revision for just six weeks of information.” The problem we confronted was that, if just the incoming data had been worse than we thought, we would not have made a revision as large as this. But in each case, the weakness in the data was being reinforced by weaker readings in the underlying fundamentals for those sectors. In consumption, for example, we have had a string of weak numbers. We lost $60 billion worth of income in downward revisions in the fourth quarter and the first quarter, and we’re starting out with a much lower saving rate than we thought. The stock market when we closed the Greenbook was off 7 percent. Those were big fundamentals. And housing, for the most part, continued to come in worse than we thought: Although new home sales came in a bit above our expectations, starts were below what we had in May, and the permits were continuing to come down. Even in this forecast, we basically have housing activity not declining a whole lot further in terms of housing starts going forward from where they are today. So we could see some downside risks still to that. If you ask where I think some of the vulnerabilities might be and how we could get to August and not be looking at a forecast as weak as this, I can imagine that by the end of the next week we could get 200,000 on payroll employment with some upward revisions. We could get a strong retail sales report for June with a little upward revision. This is all going to look a bit as though we overreacted. Things weren’t so strong. But in each case it was not as though we had actual data or fundamentals that we could hold onto to tell us not to revise as much as we did. So we thought we had things reasonably well balanced in this case. I could see more downside risks than upside risks to our housing forecast. The risks around our consumption forecast look pretty balanced to me. On the one hand, given how low the saving rate is and some recent weakening in employment growth, I could see how things could come in lower. On the other hand, it is easy to see that the consumer has been more resilient in recent years and could continue to be so. So I see the risks there as more balanced. On the business-sector side, however, I probably see a little more upside risk than downside risk to the forecast. In the end, we felt as though we were compelled by our normal analytical apparatus to produce a forecast that was noticeably weaker than the last time, even though the revision looks big and showing a forecast that changed as much in such a short time certainly made us very nervous. So I think you are right to be a bit taken aback by how much we revised in a short period; however, I still think the forecast probably has both upside and downside risks to it." CHRG-110hhrg41184--153 Mr. Hensarling," There has been some discussion--I see my time is running out--on proposed credit card legislation. Certainly I guess for the first time in almost a quarter of a century the Fed is undertaking a soup-to-nuts review of Regulation Z. You've been quoted before in budget committee, where I also served, that more expensive and less available credit seems likely to be a source of restraint on economic growth. If the credit card legislation that might be considered by Congress--and I'm not speaking of any specific bill--but if it had the net impact of causing credit card companies to increase credit cost for millions of Americans and cut off access to credit for millions of other Americans, would that be a source of concern to you? " FOMC20070131meeting--410 408,MS. PIANALTO.," Thank you, Mr. Chairman. I also want to start by saying that the memos that we received from the staff before this meeting were helpful, and I think that Vincent provided the right set of questions to guide our discussions. The goals that were laid out in the memo that Dave distributed seem appropriate to me. From that memo and the comments from David and Brian this morning, assessing whether releasing more forecast-related information will improve economic performance appears difficult. However, I am persuaded that, by making some modest changes to our current practice of preparing and releasing forecast-related information, we could readily and inexpensively facilitate a richer internal discussion and at the margin better inform the public about our thinking. So I want to say at the outset that I’m interested primarily in using the forecast to help us better understand each other’s thinking about longer-term objectives, policy risks, tradeoffs, and the workings of the economy, along the lines laid out in Vice Chairman Geithner’s memo. From my assessment of our current practices and the experience of foreign central banks laid out in Karen’s memo, I find no compelling case for releasing additional forecast-related information to the public, with one exception related to the forecast period that I’ll comment on later. So using Vincent’s language, I’m in the “modify the status quo” camp, and I’d like to answer Vincent’s questions from that perspective. I support the “independent” option regarding forecasts. I think there is great value in the diversity of opinions that individual Committee members bring to both the internal and the public discussion about monetary policy, and I would like to use it as constructively as possible. Right now, I am not in favor of pursuing a single official forecast to be published by the Committee as an element in our policy communication process. Although I am not opposed to publishing information about individual forecast submissions, I think it would be fine just to pursue the central tendency approach that we’re using and the forecast range summaries that appear in the Monetary Policy Report today. Regarding the conditioning assumptions, I think it would be counterproductive to impose a common definition of appropriate monetary policy or a common set of conditioning variables. My hope would be that the assumptions and the conditions that are important to each individual’s outlook would be revealed as part of the dialogue that we have among ourselves about our forecasts. I suggest that we incorporate a summary of our views in the semiannual Monetary Policy Report. For now, it would be enough for me to simply reflect the general sense of the conversation in the Monetary Policy Report and in our minutes, in the same way that we regularly summarize our views about the outlook and the policy situations today. I have no objection to delegating the release of a minutes-style description of the Committee’s forecast discussion to the Chairman, subject to some consultation with meeting participants in the drafting process. The process that we’re currently using to review the minutes after each meeting could be used for drafting and publishing such a description. The narrative then could be included in the release of the Monetary Policy Report, much as the central tendency forecasts are included today. My suggestion is that our forecasts continue to be shared in our semiannual format. I don’t see the need for a more-frequent release of forecasts, although listening to some of the comments today I wouldn’t be opposed to going to quarterly once we get some experience with the process. One important change that I would make is that I would supplement our current semiannual projections with a medium-term forecast for the relevant variables. Governor Mishkin mentioned three years. My personal preference is to go out to a fifth year, so I would continue to do the one and two years and then go out to the fifth year. My guess is that in most cases providing something like a five-year period is long enough to assume that the fifth year would obviously be made under the assumption of appropriate monetary policy, and that would generally align with individual members’ views of our longer-term policy objectives. Even if a five-year period is not long enough to reveal our long-run objectives perfectly, the longer period will help us to clarify the pace that the Committee members view as appropriate in terms of moving toward a more desirable inflation rate. It would also provide a description of any tradeoffs that we perceive in meeting our objectives. I am comfortable with publishing a small set of essential outcome variables, much as we do today. At some point we might want to discuss further whether it’s still useful to include nominal GDP, as others have mentioned, and what price index or indexes we should include. For now, I am not proposing that the forecast discussions be extended to include any formal measures of uncertainty. In summary, my preference is to stay much closer to the status quo than many of the other options that were presented by the staff. We have a lot to gain from shifting the focus of our internal policy discussions to include a medium term, and we can share that information qualitatively with the public at a very low cost. These modest steps would not preclude us from making more-ambitious changes that the Committee might wish further down the line. Thank you, Mr. Chairman." CHRG-111hhrg46820--101 Mr. Merski," Chairwoman Velazquez, Ranking Member Graves, and members of the committee, I am pleased to present the ICBA's views on the small business economy and on recommendations to promote an economic recovery. ICBA represents 5,000 community banks throughout our country, and community banks are independently owned and specialize in small business relationship banking. Notably half of all small business loans under $100,000 are made by community banks. Forty-eight percent of small businesses get their financing from community banks with 1 billion and under in assets. Today our small businesses are facing the most difficult economic conditions in decades and accessing credit is getting more problematic due to the turmoil in the credit markets. The National Federation of Independent Business Index of Small Business Optimism has dropped to its lowest level since it began in 1986. Additionally, the free fall in SBA lending is cause for alarm and immediate action. Therefore, fiscal policies focused on restoring consumer confidence, broad credit availability, a robust housing market and job growth are all vital to an economic recovery. We all know that many of our Nation's largest lenders and money center banks tripped up on subprime lending, toxic investments and now they are the ones pulling in their lending, writing down losses, and rebuilding their capital. However, there is another story out there. Thousands of community banks represent that other side of the financial story. Community banks rely on relationships in their communities, not on relationships with investment banks or hedge funds. Community bankers actually live and work in their communities that they serve and they certainly do not put their customers in loan products that they cannot possibly repay. While community banks did not cause the current turmoil, they are very well-positioned and willing to help get our economy back on track. To complement the aggressive monetary policy easing, ICBA recommends additional fiscal incentives, including individual and small business tax relief, enhanced home buyer tax credit, expanding SBA programs and Subchapter S tax reforms. Additionally, we really need to address our fair value accounting system and improve community banks' access to the TARP and TALF programs that this committee has worked hard on. SBA lending programs are vital. SBA lending should serve as a counterbalance during these challenging credit times for small businesses. Unfortunately, what we see is a dramatic drop in the dollar amount and number of small business loans being made. While the typical commercial small business loan has a maturity of 1 to 3 years, SBA 7(a) loans typically average 12 or more years in maturity. This lowers the entrepreneur's monthly loan payments and frees up needed cash flow to start or grow the small business. ICBA recommends immediately offering a super SBA loan program for 1 year as an economic stimulus to help small businesses access the capital they need. This could be an expedited 7(a) loan program with a 95 percent guarantee for small business loans up to 500,000. The vicious downward cycle in the housing sector must also be broken. Extending the $7,500 first-time home buyer tax credit and removing the repayment provision will help jump-start home sales, stabilize home prices, and address foreclosures. ICBA also recommends an immediate increase in the annual limit on tax-exempt municipal bonds from 10 million to 50 million. This would create greater low cost funding for local projects such as school construction, water treatment plants and other municipality projects. Chairwoman Velazquez, ICBA greatly appreciates your efforts to work with the Treasury and the Federal Reserve in successfully launching the TALF program. By providing liquidity to issuers of consumer asset backed paper, the Federal Reserve facility will enable more institutions to increase their lending. ICBA also appreciates the Small Business Committee's attention to the TARP capital purchase program. Community banks are very concerned that 3,000 financial institutions still do not have access to the capital purchase program. In conclusion, community banks did not cause this financial crisis, but we certainly will be there to help ensure our Nation's small businesses will have the access to credit that they need. I appreciate the opportunity to testify. Thank you. [The statement of Mr. Merski is included in the appendix at page 100.] " CHRG-111hhrg53248--67 Secretary Geithner," I want to just agree with one thing you said in your opening statement first, which is to say there is a lot of dumb regulation in our country. And part of our challenge is smarter regulation, not just more regulation. But I think if you look at credit products marketed to consumers, not just subprime, a broader array of mortgage products, and in the credit card area, beyond credit cards, too, there were a lot of examples of practices that we should not have tolerated in this country. " CHRG-111shrg54675--97 RESPONSE TO WRITTEN QUESTIONS OF SENATOR KOHL FROM ED TEMPLETONQ.1. I have heard from many small businesses struggling to find lines of credit and keep their doors open. How has the member business lending cap affected the ability of credit unions to make small business loans to their members? Does your organization have any data showing that more small businesses would be served if the member business lending cap was increased by loan size and volume? In the current credit crisis, do you believe that credit unions are able to provide more loans to small businesses and should the cap be raised?A.1. When Congress passed the Credit Union Membership Access Act (CUMAA) (P.L. 105-219) in 1998, they put in place restrictions on the ability of credit unions to offer member business loans. Congress codified the definition of a member business loan and limited a credit union's member business lending to the lesser of either 1.75 times the net worth or 12.25 percent of total assets. Also pursuant to section 203 of CUMAA Congress mandated that the Treasury Department study the issue of credit unions and member business lending. In January 2001, the Treasury Department released the study, ``Credit Union Member Business Lending'' that found, among other things: Overall, credit unions are not a threat to the viability and profitability of other insured depository institutions. In certain instances, however, credit unions that engage in member business lending may be an important source of competition for small banks and thrifts operation in the same geographic areas. Congress has not revisited this issue since the study came out. The arbitrary member business lending cap placed on credit unions is a detriment to credit unions ability to serve their members and America's small businesses. A number of credit unions are at or near the MBL cap, and a significant number shy away from business lending programs altogether because of the arbitrary cap and the restrictions it places on the ability to operate a business loan program. Additionally, the definition of a member business loan has not been updated for inflation in over a decade, meaning the $50,000 minimum level set in 1998 needs to be updated. Credit union economists have estimated that removing the member business lending cap could help credit unions provide $10 billion in new small business loans in the first year alone. Removing the credit union member business lending cap would help provide economic stimulus without costing the taxpayer a dime. Senator Schumer has indicated his interest in introducing legislation to remove this cap and we would urge the Committee to support him in these efforts. ------ CHRG-109hhrg31539--26 Mr. Bernanke," Yes, sir. That is a piece of good news, the natural gas prices have come down from the $12 to $14 level that we were seeing earlier. Natural gas is a bit different from oil in that natural gas is a regional market. We don't ship it internationally to the same extent that we do oil. And so we are very sensitive to the domestic supply-and-demand conditions, such as the effects of Hurricane Katrina last year and the effects of the weather over the winter. So it is a more volatile price in that respect. " CHRG-110hhrg46595--555 Mr. Altman," I think you would have to get an outside party. I don't think you could trust the companies in this case. And any of us--looking at their financial statements would be very difficult to understand. You would have to value every one of those assets, both tangible and intangible. And I do believe they have unincumbent assets. But can you get, for example Opel in Germany, can you get the German government which has a stake in this, too, in providing money to Opel under certain conditions, can you be able to transfer that equity to a lender here? It is a very good question, an excellent question, and one that I was wrestling with myself in trying to prepare the testimony. " FOMC20070807meeting--108 106,MR. MADIGAN.,"3 Thanks, Mr. Chairman. I’ll be referring to the package labeled “Material for FOMC Briefing on Monetary Policy Alternatives.” Financial markets have experienced exceptional strains over the intermeeting period. The Bluebook provided a thorough review of these developments through Thursday, and I had intended to provide only a brief summary of and update on those developments, as in exhibit 1, and some thoughts on their implications for monetary policy. But given the extensive discussions of this topic so far this morning, those points seem all to have been made, and I will turn directly to a discussion of policy alternatives. As noted at the top of exhibit 2, the risk of weakness in aggregate demand stemming from tighter credit conditions and disruptions in credit flows formed part of the rationale for the 25 basis point easing of alternative A that was presented in the Bluebook. Even if your views about the modal outlook are similar to the Greenbook baseline forecast, you may be concerned that the deterioration in credit conditions, the significant increase in market volatility, and potential declines in confidence have tilted the risks to growth distinctly to the downside. You may also see the recent spate of soft spending indicators as having raised the likelihood of sluggish growth in aggregate demand. The considerable gap between the Greenbook-consistent real federal funds rate, the dashed green line in the panel to the right, and the range of model-based estimates of the equilibrium real federal funds rate, shown in red, may add to questions about the possibility of weaker growth than in the staff forecast and reinforce your belief that some easing of policy is appropriate. Moreover, you may be more optimistic than the staff about either productivity growth or the NAIRU or both. Indeed, as I mentioned earlier, several of you noted just such optimism in the narratives accompanying your trial-run projections. The financial stimulus from a policy easing, of course, would help support growth directly. A policy action might be highly potent in current circumstances, possibly helping to buoy consumer and business confidence in a period when sentiment may well be deteriorating. You may 3 Materials used by Mr. Madigan are appended to this transcript (appendix 3). also believe that the inflation outlook would support a near-term policy easing. Core inflation readings have been relatively subdued in recent months, wage growth seems to have remained moderate, and labor market pressures may be starting to ease, although the evidence on that score is so far quite limited. In the staff forecast, core inflation converges toward 2 percent, an outcome that, judging by your projections, some of you would find acceptable—and your forecasts suggest that you think the odds favor a prompter and slightly steeper decline in inflation. In contrast, as noted in the bottom left-hand panel, you may concur with the Greenbook forecast for spending and prices, given its policy assumptions, but judge that the forecasted trajectory for inflation is too slow and leaves inflation at a level that is too high to foster optimal economic performance. If so, you may be inclined to firm policy ¼ percentage point, as in alternative C. The decline in core inflation in the Greenbook is slight and slow. As shown in the bottom right panel, the optimal control simulation in the Bluebook based on a 1½ percent target for core PCE inflation suggests an increase in the federal funds rate of about ¾ percentage point over the next year. Credibility or learning effects that might flow from a policy firming, as in the simulation, could limit the output and employment sacrifice necessary to foster a lower path for inflation. Moreover, you may agree with the staff’s baseline assumption that the effects of current market strains will prove temporary, that markets will soon resume clearing, albeit at higher and perhaps more- rational and more-sustainable spreads, and that the restraint on aggregate demand will be modest. Finally, you might see the risks to the inflation outlook as tilted to the upside, given high levels of resource utilization and increased energy prices. Alternative B, discussed in exhibit 3, may be seen as an appropriate balancing of the considerations motivating alternative A, on the one hand, and alternative C, on the other. Under this alternative, the Committee would leave the stance of policy unchanged today. The statement would acknowledge the recent volatility of financial markets and tighter credit conditions but would also convey an expectation that moderate growth will likely continue. Core inflation would be characterized as subdued in recent months but subject to upside risk. The Committee would expressly refer to increased downside risk to growth but indicate that its predominant policy concern remains the risk that inflation will fail to moderate as expected. A rationale for alternative B is laid out in the upper left-hand panel. In the baseline Greenbook forecast, the economy expands at a moderate pace, resource pressures ease slightly, and core inflation ebbs to 2 percent with the federal funds rate held at its current level through next year. That forecast may be close to your own view about the modal result, and you may see it as an acceptable outcome. As shown to the right, optimal control simulations based on the Greenbook baseline and an assumed core inflation objective of 2 percent would suggest leaving the federal funds rate unchanged for the rest of the year before easing slightly. Returning to the left- hand panel, holding steady at this meeting would also be consistent with the Committee’s past behavior as captured by the estimated outcome-based and forecast- based policy rules presented in the Bluebook. You may also believe that alternative B represents a suitable weighting of the risks. For example, even if you are a bit more optimistic about potential growth and the NAIRU than the staff, you may nonetheless see maintaining the federal funds rate at its current level as an appropriate risk-management approach, given the upside risks to inflation and the higher costs should they be realized. Careful consideration of the most recent developments also may incline you toward alternative B. In particular, even if the incoming data and increased financial market strains of recent weeks incline you to believe that the downside risks to growth have increased, you may be quite unsure about the extent of those risks and not wish to exaggerate them. As suggested by yesterday’s developments, it is not inconceivable that markets will soon begin to right themselves and that the Greenbook baseline assumption of only modest financial restraint will prove correct. In these circumstances, watchful waiting may be the best approach in order to allow more information to accumulate that will enable you to better assess the likely eventual adjustments of market prices and flows and the appropriate policy response. Indeed, you may be especially concerned about the risk of overreacting (or being perceived as overreacting) to temporary market developments—particularly if you see a significant probability that markets could misinterpret changes in the stance of policy, or in your words, as an indication that you place a higher priority on financial market stability or economic growth than on price stability. Moreover, your inflation concerns may not have diminished much, if at all, over the intermeeting period. While the most recent core inflation readings have been relatively low, you may concur with the staff that some of that good performance will likely prove transitory. Also, overall inflation has remained high, and with resource utilization elevated, you may be worried that high rates of overall inflation could allow inflation expectations to move higher. The statement associated with the revised version of alternative B is provided in the bottom panel. Given the volatile market conditions of late, getting a reliable read on market participants’ expectations at this point is difficult, but an announcement roughly along these lines seems to be anticipated by most market participants. Notably, the statement explicitly mentions downside risks to growth. That mention may be seen as opening the door a crack to future easing or at least giving the Committee greater scope to move in that direction. Although only a minority of market participants apparently expect the Committee to point explicitly to downside risks to growth, a sizable market reaction to the inclusion of such a reference in paragraph 4 seems unlikely, as the Committee still would state that inflation risks are its predominant concern. The final exhibit is an updated version of table 1 for your reference. Changes" CHRG-111shrg54675--81 PREPARED STATEMENT OF JACK HOPKINS President and Chief Executive Officer, CorTrust Bank National Association, Sioux Falls, South Dakota, On Behalf of the Independent Community Bankers of America July 8, 2009Introduction Mr. Chairman and Members of the Subcommittee, thank you very much for the opportunity to testify today on the state of community banks in rural America. My name is Jack Hopkins and I am the President and CEO of CorTrust National Bank Association in Sioux Falls, SD. I am testifying on behalf of the Independent Community Bankers of America (ICBA) and I serve on ICBA's \1\ Executive Committee. I am a past President of the Independent Community Bankers of South Dakota and have been a banker in South Dakota for 25 years. I am pleased to present ICBA's views on the state of credit conditions in rural America.--------------------------------------------------------------------------- \1\ ICBA represents 5,000 community banks throughout the country. Community banks are typically independently owned and operated and are characterized by personal attention to customer service and are proud to support their local communities and the Nation's economic growth by supplying capital to farmers and ranchers, small businesses, and consumers.--------------------------------------------------------------------------- CorTrust is a National Bank with 24 locations in 16 South Dakota Communities and assets of $550 million. Eleven of the communities have less than 2,000 people. In seven of those communities, we are the only financial institution. The smallest community has a population of 122 people. CorTrust Bank is currently one of six authorized servicers in the State of South Dakota for the first-time homebuyers program and one of the leading South Dakota lenders for the U.S. Department of Agriculture (USDA) Rural Housing Service home loan program. Today's testimony will briefly provide the community bank perspective on credit conditions in rural America and offer recommendations for the Members of this Subcommittee to consider to ensure the availability of vital credit to our rural communities.The Financial Crisis As the financial crisis spread and deepened last fall many people wondered what the impact of the worst economic recession since the Great Depression would be on rural America. At the outset, it is important to note, community banks played no part in causing the financial crisis and have watched as taxpayer dollars have been used to bail out Wall Street investment firms and our Nation's largest banks considered ``too-big-to-fail.'' During this same time period, dozens of community banks have been allowed to fail while the largest and most interconnected banks have been spared the same fate due to government intervention. Mr. Chairman, community banks did not cause the current financial crisis, fueled by exotic lending products, subprime loans, and complex and highly leveraged investments. The sharp decline in the U.S. housing markets and the distressed credit markets triggered a ripple effect throughout the entire economy and that continues to strain households and businesses.Community Banks' Role in the Rural Economy Community banks play an important role in the Nation's economy. There are approximately 8,000 community banks in the U.S. and the vast majority of these are located in communities of 50,000 or fewer residents. Thousands of community banks are in small rural communities. According to the SBA Office of Advocacy, insured institutions with less than $1 billion in assets make 31.3 percent of the total dollar amount of small business loans of less than $1 million, even though they hold only 11.5 percent of industry assets. This is important since small businesses represent 99 percent of all employer firms and employ one-half of the private sector workforce. Small businesses are significant in rural America since many farmers and/or their spouses have off-farm jobs. In addition, the more than 26 million small businesses in the U.S. have created 70 percent of the net new jobs over the past decade. Community banks are small businesses themselves and specialize in small business relationship lending. Commercial banks extend approximately 53 percent of non-real-estate loans to the farm sector and 38 percent of the real estate credit. Community banks under $1 billion in assets make over 60 percent of all agricultural loans extended by the commercial banking sector. Worthy of note, community banks under $500 million in assets extend over 50 percent of all agricultural credit from the banking sector.Aite Study The Aite Group LLC released a study, \2\ conducted with the assistance of the ICBA, in March 2009, on the impact of the financial crisis on community banks. The study drew several conclusions regarding the ability of community banks to continue serving their customers during the financial crisis.--------------------------------------------------------------------------- \2\ Impact of the Financial Crisis on U.S. Community Banks, New Opportunities in Difficult Times, March 2009, Christine Barry and Judy Fishman, Aite Group LLC, Boston, MA. 773 community banks were surveyed in February, 2009, for this study.--------------------------------------------------------------------------- Although the current financial crisis is impacting all financial institutions, most community banks are well-positioned to overcome new challenges, take advantage of new opportunities, and reclaim some of the deposits lost to larger institutions over the last decade. Despite most community banks' lack of participation in subprime lending, the implications of larger bank activities have had an impact. Of the 773 community banks surveyed, 73 percent stated they have seen an increase in their traditionally low loan delinquencies and charge-offs since the start of the crisis. The significant growth in quarterly net charge-offs for the industry is being driven primarily by the largest banks. Fifty-five percent of bankers stated they have seen an increase in deposits as a result of new customer acquisition. Only 17 percent are challenged by customers withdrawing deposits from their institutions. Community banks are still lending and 40 percent have seen an increase in loan origination volumes over the last year, while 11 percent believe the financial crisis has ``significantly curtailed'' their lending ability. In several cases, decreases in community bank lending activity, when it has occurred, is not the result of a lack of funds or financial instability, but rather part of a reaction to mixed messages coming from the U.S. government. While these banks are told by policy makers to lend money, they also feel the agencies are dissuading them from lending by putting them through overzealous regulatory exams. Moreover, an economic contraction, by definition, means fewer loans will be originated. Even though some community banks are faced with new lending challenges, they are still lending, especially when compared to larger banks. In fact, while the largest banks saw a 3.23 percent decrease in 2008 net loans and leases, institutions with less than $1 billion in assets experienced a 5.53 percent growth. The financial crisis and new documentation requirements are also causing some banks to change processes and reexamine their credit evaluation practices. While most community banks have not strayed from traditional prudent lending and underwriting practices, 81 percent have tightened their credit standards since the start of the crisis. Of banks surveyed, 20 percent described this tightening as significant. Banks with more than $100 million in assets have been the most likely to tighten their credit standards, while only 15 percent of banks with less than $100 million in assets have done so. In most cases, tighter standards often means focusing greater attention on risk management and requiring more borrower information prior to making lending decisions.Small Business Lending The prolonged recession, turmoil in the financial markets, and procyclical bank regulatory policies continue to jeopardize credit availability for many small businesses in urban and rural areas. Community banks are well-positioned and willing to lend to small businesses especially during these challenging economic circumstances. ICBA strongly supports President Obama's and Congress' recent initiatives to bolster small businesses loan programs included in the American Recovery and Reinvestment Act of 2009. Small businesses will help lead us out of the recession and boost needed job growth. Therefore, it is important to focus on the policy needs of the small business sector during this economic slowdown. SBA lending must remain a viable and robust tool in supplying small business credit. The frozen secondary market for small business loans continues to impede the flow of credit to small business. Several programs have been launched to help unfreeze the frozen secondary market for pools of Small Business Administration (SBA) guaranteed loans, including the Term Asset-Backed Securities Loan Facility (TALF) and a new SBA secondary market facility. The TALF, implemented by the Federal Reserve and U.S. Treasury, was intended to extend billions in nonrecourse loans to holders of high-quality asset-backed securities (ABS) backed by consumer and small business loans in a bid to free up the frozen ABS market. Specifically, the TALF program for SBA secondary market loan pools is very close to success. Unfortunately, one program obstacle requiring third-party direct competitor primary dealers to be middlemen has completely stalled the program. SBA loan poolers will not turn over their customers to their direct competitors nor have the primary dealers engaged in the program to date. ICBA recommends either eliminating the primary dealer middlemen in the process or allowing the Federal Reserve Bank of New York to work as the intermediary with the existing SBA loan poolers. Similarly, the new SBA secondary market program is close to success but the debate over potential additional fees to operate the program has stalled its launch. ICBA recommends using the enacted substantial funded budget authority to run the program in combination with user fees so as not to undermine the program with unworkable double fees. ICBA believes with these minor adjustments, these targeted SBA secondary market programs will keep money flowing to consumers and small businesses providing the intended value and results. In addition, government sponsored enterprises and U.S. government loan programs should not reject a loan for the sole reason the property is in a declining market.The Agricultural Sector--Farm Income Many rural lenders have been quite concerned that a global recession would lead to fewer exports of U.S. agricultural products, thereby reducing markets and income for American farmers, and causing a ripple effect up and down Main Street. The agricultural sector was fortunate that at the outset of this severe recession, in which unemployment figures continue to march toward double digit levels, U.S. net farm income had reached a record high of nearly $90 billion for 2008. This followed the $87 billion level reached in 2007 and a 10-year average (1999-2008) of $65 billion. However, production expenses also increased dramatically during the past 2 years, and although expenses are projected to be approximately 9 percent lower this year, net cash income is also projected to fall to $71 billion. While still above the 10-year average, 2009 net farm income will be 18 percent less than last year's record level, according to USDA's Economic Research Service.Perspective on Agricultural Credit ICBA agrees with various economists who have noted there is an ample amount of credit available to the agricultural sector for credit worthy borrowers. However, there are several problem areas of concern that warrant continued monitoring. For example, the dairy industry has been hard hit by lower prices and high feed costs which have also impacted the livestock sector. In addition, there are several States where farmers have been impacted by drought conditions that will threaten yields and farm income. In recent testimony before the House Agriculture Committee, the Federal Reserve Bank of Kansas City stated that despite some increasing risks in agriculture, ample credit appears available at historically low interest rates. \3\ In addition, recent data from the FDIC indicates farm loans (non-real-estate) and farm real estate loans increased collectively by $8 billion for the period ending March 31, 2009, compared to March 31, 2008.--------------------------------------------------------------------------- \3\ Jason Henderson, Federal Reserve Bank of Kansas City before the Subcommittee on General Farm Commodities and Risk Management, April 1, 2009, page 2.---------------------------------------------------------------------------ICBA's Agriculture-Rural America Committee Input ICBA conducted a conference call last month with its Agriculture-Rural America Committee to further assess credit conditions. This committee consists of 25 agricultural bankers from every region of the U.S. representing virtually every agricultural commodity grown in the country. A number of these bankers stated they had no classified agricultural loans. This is in part due to several areas of the country having excellent crops during the past 2 years, allowing farmers to increase their cash reserves or pay down their lines of credit. Some bankers have seen a significant increase in agricultural loans and have seen little deterioration in their agricultural portfolios but are concerned higher input costs will reduce farm income. Some community banks have picked up agricultural loans as larger banks have cut back their lines of credit. Land values have remained steady for highly productive farm land although sales have slowed considerably. Land values for less productive farmland have fallen 5 to 10 percent in some areas. Some banks have tightened underwriting standards, including taking a stronger collateral position, slightly shortening loan maturities, or requiring greater documentation from borrowers. The dairy, cattle feeding, and cow-calf sectors are areas experiencing stress. Several bankers stated they are concerned with the potential for their regulators to second-guess their desire to make additional loans and some bankers are under pressure from their regulators to decrease their loan-to-deposit ratios. In addition, several bankers stated their regulators do not want them to use Federal Home Loan Bank (FHLB) advances as a means of funding their loans. The regulators are suggesting FHLB advances are not as ``stable'' as core deposits. Bankers disagree, noting it is quite easy for depositors to withdraw funds in search of higher yields in the stock market, which has risen rapidly in recent months, or in shopping for higher rate Certificates of Deposit (CD) at other institutions. The real issue, bankers believe, is that regulators do not want to be in a secondary security position behind the FHLB if there are widespread bank failures. FHLB advances have become an important source of funding for community banks that must be allowed to continue. A number of bankers also complain about a very harsh examination environment from field examiners and believe there is a ``disconnect'' between the public statements from policy makers in Washington and the treatment of local banks during examinations. This bolsters the findings of the Aite study. At least one banker relayed to other committee members when he called the regulator to inquire about receiving TARP funds he was questioned as to why he needed the money. When he explained he wanted to supplement his capital position and also make more loans, the regulator told him the agency didn't want banks making more loans in this environment. This attitude has led many community banks to conclude there is reluctance to extending TARP money to community banks and that the program was primarily designed to assist large, troubled banks. Community banks in danger of failing would not be eligible for TARP funds. In addition, many banks have concluded TARP funds are an expensive source of capital both in terms of the dividend cost as well as the administrative costs. \4\ There is also the risk requirements will be changed after banks receive funding and new conditions will be imposed.--------------------------------------------------------------------------- \4\ The cost of TARP funds includes a 5 percent dividend payment for the first 5 years increasing to 9 percent after 5 years. On an after tax basis, ICBA estimates the cost would be 7.5 percent the first 5 years and 13.5 percent after the first 5 years.--------------------------------------------------------------------------- Generally, the bankers' conclusions are that ample credit is available for creditworthy borrowers; they would like to make more loans; and they're concerned about heavy-handedness from their regulators going forward. It is important to repeat: community banks remain very well-capitalized and are in a good position to assist with new borrowing needs as the economy strengthens. While, there are some sectors of agriculture that are struggling; the agricultural portfolios at many rural banks strongly contribute to each bank's overall income and stability. One limiting issue is that regulators recently required community banks to increase their capital levels. Previously, regulators increased community bank capital levels from 8 percent to 10 percent. Now the regulator requires a 12 percent capital level for all banks that have commercial real estate loan volumes three times their level of capital (e.g., $30 million in commercial loans and $10 million of capital). Obviously, the regulators believe commercial real estate loans are more vulnerable in the current economic climate. For example, many banks in northern Colorado exceed this threshold due to the region's fast growth in recent years. However, since capital is leveraged approximately 10 times for new lending, a $2 million increase in capital reduces the amount of lending the bank is able to provide by $20 million. Many rural bankers believe this new requirement is unnecessarily restrictive.Federal Reserve Bank Agricultural Surveys Several of the Federal Reserve District banks (Kansas City, Dallas, Chicago, Minnesota, and Richmond) conduct quarterly agricultural surveys of bankers in their regions. A summary of these surveys follows. The Federal Reserve Bank of Kansas City \5\ notes the average return on assets (ROA) and equity (ROE) at agricultural banks steadily declined in 2008. ROE at ag banks last September declined to 7.6 percent and ROA declined to 0.8 percent. Yet, these returns were much stronger than returns at other commercial banks. Contributing to the decline in ag bank profits were lower interest rates which have dropped significantly below 2006 levels. At smaller banks, delinquency rates on agricultural loans actually declined. Delinquency rates and net charge-offs on agricultural loans remain well below other types of loans and help explain the relative strength of agricultural banks. The delinquency rate on all types of loans and leases in the third quarter of 2008 was almost triple the rate of agricultural loans. Ag banks report ample funds for operating loans.--------------------------------------------------------------------------- \5\ The Kansas City region, the Tenth Federal Reserve District, includes Colorado, Kansas, Nebraska, Oklahoma, Wyoming, the northern half of New Mexico and the western third of Missouri.--------------------------------------------------------------------------- Banks have tightened lending standards to preserve capital and manage risk arising from the economic downturn. Collateral requirements rose almost 20 percent above year-ago levels but this increase does not appear to have severely restricted loan activity as farm real estate accounted for approximately 17 percent of the collateral used for the Nation's farm operating loans. Bankers report deteriorating loan quality as livestock profits were elusive and margins declined for the crop sector. Carry-over debt appears to be rising as more ag banks report an increase in operating loan renewals and extensions during the fourth quarter. In response to rising risks, banks reduced the length of operating loans to approximately 12 months. Rising job losses from the recession pose a risk to deposit growth because people could lose their income stream and tap savings for household needs. Ag banks are increasing their use of USDA guaranteed farm loans. Continued deterioration in the agricultural economy could further erode the creditworthiness of borrowers. Farmland values edged down in the fourth quarter. The Federal Reserve Bank of Minneapolis \6\ reports farm income, capital expenditures, and household spending decreased in the first quarter. Loan demand was flat and collateral requirements increased. Banks reported no shortage of funds and interest rates decreased from the fourth quarter of 2008. Survey respondents expect decreases in income and capital expenditures during the second quarter. Dairy producers are hard hit as the price of milk has fallen to below breakeven levels. Most respondents from Wisconsin report below average income for their borrowers. One quarter of Minnesota respondents reported above average income, but 49 percent reported below average income. Producers are responding to lower spending by reducing capital equipment spending. Approximately 25 percent of respondents reported lower levels of loan repayments and 19 percent reported higher levels. Twenty-five percent saw higher renewals or extensions and only 8 percent saw lower levels.--------------------------------------------------------------------------- \6\ The Minneapolis Federal Reserve serves the six States of the Ninth District: Minnesota, Montana, North and South Dakota, 26 counties in northwestern Wisconsin, and the Upper Peninsula of Michigan.--------------------------------------------------------------------------- The Federal Reserve Bank of Dallas \7\ includes the States of Texas and portions of New Mexico and Louisiana, a region impacted by a severe drought. Many ranchers are unable to reach a breakeven point, forcing livestock liquidations. The dairy industry is suffering from large losses. The outlook for crop production, due to the lack of moisture, remains bleak. Eighty-four percent of bankers report loan demand remains unchanged or has decreased compared to last quarter.--------------------------------------------------------------------------- \7\ The Federal Reserve Bank of Dallas covers the Eleventh Federal Reserve District, which includes Texas, northern Louisiana, and southern New Mexico.--------------------------------------------------------------------------- The Federal Reserve Bank of Chicago \8\ reports sale of farms were below the levels of the prior year. Bankers anticipate declines in land values during the second quarter. For the second quarter of 2009, respondents expect higher loan demand for operating loans and USDA guaranteed loans. As of April 1, District interest rates had reached historically low levels with the level for operating loans at the lowest since the early 1970s. The average loan-to deposit ratio was 76 percent, or 4 percent below the desired level. As land values have stalled, cash rental rates for farmland increased 7 percent for 2009. Twenty-one percent of bankers reported more funds for lending were available than a year ago and 9 percent reported fewer funds were available.--------------------------------------------------------------------------- \8\ The Chicago Fed serves the Seventh Federal Reserve District, a region that includes all of Iowa and most of Illinois, Indiana, Michigan, and Wisconsin.--------------------------------------------------------------------------- Bankers expect the volume of non-real-estate farm loans to grow during the second quarter compared to year ago levels and expect higher FSA guaranteed loan demand. They expect farm machinery, grain storage construction, feeder cattle, and dairy loan volumes to decrease. The Federal Reserve Bank of Richmond's \9\ fourth quarter 2008 survey reported the demand for farm loans was little changed from its sharp drop off in the third quarter, which bankers attributed to variations in commodity prices and production costs. Lenders expressed concern about escalated feed costs which had reduced profits for livestock production. Requests for loan renewals or extensions increased at a quicker pace. Agricultural lenders reported that farm loan availability turned positive, and collateral requirements eased slightly from third quarter levels. Reports also indicated interest rates for agricultural loans moved lower across all categories. Compared to third quarter levels, rates for intermediate-term loans decreased 34 basis points and rates for operating loans moved down 28 basis points. In other categories, interest rates for long-term real estate loans fell 19 basis points (bp), and interest rates for feeder cattle loans dropped 10 bp.--------------------------------------------------------------------------- \9\ The Federal Reserve Bank of Richmond, (Fifth district) comprises Maryland, the District of Columbia, Virginia, North Carolina, South Carolina, and most of West Virginia.--------------------------------------------------------------------------- In the fourth quarter, 75 percent of lenders reported that they had actively sought new farm loans, up slightly from last quarter's reading of 73 percent. Fourth quarter land prices were slightly below the previous quarter and considerably lower than year ago levels. Bankers expected farm loan volumes in the first quarter of 2009 to continue a downward trend led by further weakness in the demand for dairy and feeder cattle loans.National Agriculture Risk Education Library Survey In an effort to better understand what is happening in the agricultural economy, a survey \10\ was conducted in January 2009 by the Extension Risk Management Education Regional Centers and the Center for Farm Financial Management at the University of Minnesota, funded through the USDA CSREES Risk Management Education Program. Twenty-three hundred agricultural professionals responded to the survey, whose respondents represented various agricultural disciplines: Lenders: 21 percent; educators: 43 percent; crop insurance representatives: 7 percent; consultants: 6 percent--elevators, cooperatives, marketing brokers, and nonprofits: 22.5 percent.--------------------------------------------------------------------------- \10\ This survey can be accessed at: http://www.agrisk.umn.edu/Library/Display.aspx?RecID=3971.--------------------------------------------------------------------------- Currently, 63 percent of respondents stated that 10 percent or less of the producers they work with are experiencing financial stress, with 15 percent indicating that less than 2 percent of the producers they work with are currently experiencing financial stress. In the next 3 years, however, more than 28 percent of respondents expect at least 30 percent of their agricultural clients will experience financial stress. Seventy-five percent of respondents expect 11 percent or more of producers will experience financial stress in the next 3 years. Twenty-six percent of lenders think the probability is very high that producers will experience financial stress in the next 3 years. Fifty-four percent of lenders expect the probability of financial stress to be ``high.'' It is particularly interesting to note the reasons stated for expected financial stress in agriculture over the next 3 years. The first five reasons given were: Price/input cost margins; price volatility; negative cash flows; inadequate business planning; and lack of financial planning skills. Tightening credit availability was sixth on the list of thirteen reasons and was cited as having ``moderate'' impact. The lowest rated factors expected to have an impact on farm financial stress were rising interest rates and declining land values.Farm Credit System Considerations The Farm Credit System (FCS) is a government sponsored enterprise (GSE) that, unlike other GSEs, competes with private sector lenders at the retail level. The financial crisis has proven that not only do GSEs have the implicit backing of the Federal Government; they also have the explicit backing of the Federal Government. Just like the Nation's largest banks, they would not be allowed to fail in times of financial difficulty. The FCS, as a competitor with community banks, also has unique advantages--it can typically raise funds cheaply in the government debt markets and FCS institutions have numerous tax advantages enabling them to offer lower rates than commercial banks. This has led to FCS entities ``cherry picking'' prime farm loans from community banks as FCS institutions seek the very best customers from bank portfolios. Allowing this practice, unintended by Congress, can discourage community bank involvement in the agricultural sector, reducing the amount of resources and institutions available to farmers. The performance numbers of the FCS indicates this as well. Compared to commercial ag banks' ROE of 7.6 percent and ROA of 0.8 percent for September 2008, FCS associations' ROE for the same time period was 10.85 percent and associations' ROA was 1.70 percent. Community banks serving agriculture should receive the same tax benefits as FCS associations. In this century, it no longer makes sense to provide billion-dollar and multibillion dollar FCS institutions tax advantages over much smaller commercial lenders to compete for the same customers. The benefit of equalizing the playing field will accrue to the end-user--the farmers and ranchers.Administration's Regulatory Reform Proposals ICBA supports the administration's goals of making the overall financial system more resilient and less vulnerable to ``too-big-to-fail'' institutions that were a key factor in the recent financial turmoil. The administration's proposal offers community banks both constructive measures ICBA will support and those ICBA will oppose. The proposal addresses a longtime ICBA priority by dealing with the risks created by ``too-big-to-fail'' institutions. It is a good, strong step in the right direction but Congress needs to go further. ICBA is pleased the administration decided to maintain the dual banking system. This will allow the maintenance of Federal and State bank charters and allow the concerns of community banks to be heard, rather than to be drowned out by the larger and more complex financial institutions.ICBA Recommendations to Congress While it is difficult to predict accurately what will happen in the economy in the next two or three quarters, we believe Congress can have a positive influence by making a number of key policy choices. ICBA recommends: 1. Provide additional funding for USDA direct and guaranteed farm loans. Prior to the July congressional recess, Congress passed and the President signed the supplemental appropriations bill which added $400 million of direct operating loans, $360 million in direct ownership loans and $50 million in guaranteed operating loans. There may be a need even more for guaranteed operating loans and Congress should closely monitor loan demand in these important programs. These programs assist borrowers who cannot obtain credit elsewhere and are an important backstop for farmers who need temporary assistance until they are able to graduate to commercial credit. 2. Enhance USDA's Business and Industry (B & I) loan program. Congress added significant new money for USDA's rural development efforts as part of the recently enacted economic stimulus package (P.L. 111-5). The new funding would allow an additional $3 billion of business and industry loans in addition to $1 billion of loans provided as part of USDA's regular budget. However, the funds to provide $3 billion in new B & I loans will expire October 1, 2010. It will be important for USDA to aggressively market the program to lenders and provide adequate information in order to utilize these new funds. Even more importantly, the B & I program needs to be enhanced (at least for the new funding) by: (A) implementing no more than a one percent origination fee; (B) increasing guarantees on loans under $5 million from the current 80 percent level to 90 percent--perhaps even 95 percent on smaller loans; and (C) not eliminating the low document application as USDA appears to be on the verge of doing for smaller loans. These changes would help ensure the program is attractive for lenders and their customers and will ensure Main Street rural America has the resources necessary to ride out any storms on the horizon that could result from stress in the agricultural sector. 3. Ensure that the FCA does not proceed with its Rural Community Investments Proposal. This proposal poses significant new risks to the FCS and its borrowers and should not be adopted. The proposal appears to be illegal and was never considered or authorized by Congress. It allows FCS to extend credit, mislabeled ``investments,'' for a vast array of purposes never intended by Congress. These purposes include extending credit for nonfarm business financing, apartment complexes, construction projects and virtually any other purpose. This wide nonfarm reach of FCS institutions will move FCS lenders further away from serving farmers and ranchers--the specific reason it was created and granted GSE tax and funding privileges. 4. Ensure the regulators not unduly restrict lending by community banks. Regulators can have a major impact on the ability of lenders to extend credit particularly if they engage in unduly harsh examinations at the local level. Many community banks believe this is occurring. Members of Congress should interact with regulatory agencies and stress the need to allow the banking sector to work with rural customers during difficult financial times that may lie ahead. Such regulatory flexibility allowed many farmers and small businesses to survive the turbulent times of the 1980s farm crisis but was the result of clear and strong messages sent by Congress. 5. Avoid unintended consequences resulting from imposing new requirements on the banking sector. In recent months there have been various proposals aimed at bank recipients of TARP funds that would impose unnecessary costs and regulatory burdens on banks. Such proposals have included requiring commercial banks to write down principal and interest on troubled loans as the first option to consider when restructuring loans. Bankers already work with their customers and utilize a wide variety of options to keep customers in business. Washington should allow community banks to work with borrowers in troubled times without adding to the costs and complexity of working with customers. 6. Support the Administration's proposals on systemic risk and dual banking charters. It is important to prevent ``too-big-too- fail'' banks or nonbanks from ever threatening the collapse of the financial system again. Community banks support the dual system of State and Federal bank charters to provide checks and balances, which promote consumer choice, and a diverse and competitive financial system that is sensitive to financial institutions of various complexity and sizeConclusion Thank you, Mr. Chairman, for the opportunity to testify today. As stated several times in the written testimony, community banks continued conservative and prudent lending practices during the last several years and have worked with borrowers and even increased lending during this latest period of economic contraction. In addition, thousands of community banks are providing loans to farmers, ranchers, and small businesses at historically low interest rates. ICBA urges the Banking Committee to consider the recommendations provided in the testimony to enable the community banking sector to do even more to serve our rural communities. ICBA looks forward to working with the Senate Banking Committee as these proposals move through Congress. ______ CHRG-111hhrg48868--369 The Chairman," Well, I won't give you that assurance, sir. And so if that's the condition, it would be my intention to ask this committee to subpoena them. This is a situation where there is a lot of public activity. I ask you to submit the names of the people who have received the bonuses, noting that they paid them back, or not, and I would accept them under a confidentiality personally. In fact, you have submitted some confidential information, and I frankly threw it away after reading it, because I was afraid I would inadvertently breach the confidentiality. But I do ask that you submit those names with restriction, and if you feel unable to do that, then I will ask the committee to subpoena them. " CHRG-111hhrg58044--18 Mr. Garrett," I thank the chairman, and I thank the ranking member, and I thank the members of the panel who are here. Credit information has obviously become an essential and valuable tool in allowing various market participants to more accurately price for the risk. One of the areas we are examining today is how this information is used by property casualty insurance companies in determining the premiums they charge to their clients. There have been numerous actuarial reports that have studied this. By using consumer-based insurance or CBIS, in determining premium rates for P&C lines, insurance companies are basically more able to accurately price for the risk of the consumer and the rates have significantly decreased for a broad majority of the policyholders. Credit scores are really just one of a number of different data points that insurers consider when determining a consumer's premium. If we were to now limit or restrict certain types of information from being used to allow insurers to more accurately price for risk, two things are going to happen: One, more people will pay higher premiums; and two, fewer people will be able to purchase insurance. Neither of these things are good. In the wake of the recent financial crisis, instead of looking for ways to decrease credit availability and the accurate pricing of risk, I believe Congress should be considering policies that will help expand credit for consumers and small businesses and lower the cost of credit and insurance premiums for the majority of Americans. With our current unemployment rate around 10 percent, we really must work on initiatives to expand economic opportunities for all Americans, not ways for the government to micro-manage our Nation's small businesses and risk trying to restrict the aggregate price of risk. With that, I yield back the balance of my time. " FOMC20060510meeting--100 98,MR. POOLE.," Okay. Anyway, he said that their construction costs—for a store, I guess—have come in 27 percent above expectations. Their construction costs are even higher in the Gulf Coast area. He also said that Wal-Mart is in the process of raising starting wages in about 700 stores. This is the first time in eight years of talking with him that I’ve heard any comment like that. He said that some of the raises are part of the Wal-Mart, I’ll call it “social/political,” agenda because of all the controversy about Wal-Mart. But he said about 125 of these were market driven, that they have plenty of labor in rural areas and in urban areas, but they are developing a labor supply problem for their stores in suburban areas. Suburban areas are strong. I have received some unsolicited e-mail messages—well, I guess to be fair they’re sort of solicited. [Laughter] These are from two directors: “Heavy construction industry is really hot. In the past month, I have received reports of a second round of capital cost increases of 25 to 40 percent in the refining industry, and the same for construction of large power plants. These estimates follow similar increases last summer.” Another message discussed pressures on the cost of construction materials. I won’t read the whole thing. It says, “We believe we are now on the front side of a real surge in prices that will mainly affect highly volatile commodity building products—steel, copper, aluminum, and zinc. However, if it is sustained, it will ripple across a broad range of more-manufactured products.” Now, very briefly, I’ve made a list of what I think are classic inflation warning signs, and I’ll just rattle these off very quickly. Inflation expectations—we’ve talked about that. Dollar depreciation. Commodity prices are really breaking out of a trading range that has prevailed for about fifteen years— if you look at the chart in the Greenbook Part 2, you’ll see that. The surge in construction costs—I think there is a building boom indicating business confidence, and, of course, a direct source of aggregate demand. Relatively low risk spreads, making it easy for firms to raise capital. Strong stock market. Strong corporate profits. From our anecdotal information, some increase in pricing power. And a worldwide boom. There is growth in almost every region of the world, and, of course, that translates to some extent into price pressures everywhere, including goods that we import and goods that we export, at least eventually. I’ll stop there. Thank you." fcic_final_report_full--316 In May and June , Citigroup entered into memoranda of understanding with both the New York Fed and OCC to resolve the risk management weaknesses that the events of  had laid bare. In the ensuing months, Fed and OCC officials said, they were satisfied with Citigroup’s compliance with their recommendations. Indeed, in speaking to the FCIC, Steve Manzari, the senior relationship manager for Citigroup at the New York Fed from April to September , complimented Citigroup on its assertiveness in executing its regulators’ requests: aggressively replacing manage- ment, raising capital from investors in late , and putting in place a number of much needed “internal fixes.” However, Manzari went on, “Citi was trapped in what was a pretty vicious . . . systemic event,” and for regulators “it was time to come up with a new playbook.”  Wachovia: “The Golden West acquisition was a mistake” At Wachovia, which was supervised by the OCC as well as the OTS and the Federal Reserve, a  end-of-year report showed that credit losses in its subsidiary Golden West’s portfolio of “Pick-a-Pay” adjustable-rate mortgages, or option ARMs, were ex- pected to rise to about  of the portfolio for ; in , losses in this portfolio had been less than .. It would soon become clear that the higher estimate for  was not high enough. The company would hike its estimate of the eventual losses on the portfolio to  by June and to  by September. Facing these and other growing concerns, Wachovia raised additional capital. Then, in April, Wachovia announced a loss of  million for the first three months of the year. Depositors withdrew about  billion in the following weeks, and lenders reduced their exposure to the bank, shortening terms, increasing rates, and reducing loan amounts.  By June, according to Angus McBryde, then Wachovia’s senior vice president for Treasury and Balance Sheet Management, management had launched a liquidity crisis management plan in anticipation of an even more adverse market reaction to second-quarter losses that would be announced in July.  On June , Wachovia’s board ousted CEO Ken Thompson after he had spent  years at the bank,  of them at its helm.  At the end of the month, the bank an- nounced that it would stop originating Golden West’s Pick-a-Pay products and would waive all fees and prepayment penalties associated with them. On July , Wachovia reported an . billion second-quarter loss. The new CEO, Robert Steel, most re- cently an undersecretary of the treasury, announced a plan to improve the bank’s fi- nancial condition: raise capital, cut the stock dividend, and lay off  to  of the staff. CHRG-111shrg52619--211 RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM GEORGE REYNOLDSQ.1. It is clear that our current regulatory structure is in need of reform. At my subcommittee hearing on risk management, March 18, 2009, GAO pointed out that regulators often did not move swiftly enough to address problems they had identified in the risk management systems of large, complex financial institutions. Chair Bair's written testimony for today's hearing put it very well: `` . . . the success of any effort at reform will ultimately rely on the willingness of regulators to use their authorities more effectively and aggressively.'' My questions may be difficult, but please answer the following: If this lack of action is a persistent problem among the regulators, to what extent will changing the structure of our regulatory system really get at the issue?A.1. We do not perceive that lack of action is a problem among the state credit union regulators. In fact, the authority given to state regulators by state legislatures allows state regulators to move quickly to mitigate problems and address risk in their state-chartered credit unions. NASCUS \1\ believes that the dual chartering structure which allows for both a strong state and federal regulator is an effective regulatory structure for credit unions.--------------------------------------------------------------------------- \1\ NASCUS is the professional association of state credit union regulatory agencies that charter, examine and supervise the nation's 3,100 state-chartered credit unions. The NASCUS mission is to enhance state credit union supervision and advocate for a safe and sound credit union system.--------------------------------------------------------------------------- State and federal credit union regulators regularly exchange information about the credit unions they supervise; it is a cooperative relationship. The Federal Credit Union Act (FCUA) provides that ``examinations conducted by State regulatory agencies shall be utilized by the Board for such purposes to the maximum extent feasible.'' \2\ Further, Congress has recognized and affirmed the distinct roles played by state and federal regulatory agencies in the FCUA by providing a system of consultation and cooperation between state and federal regulators. \3\ It is important that all statutes and regulations written in the future include provisions that require consultation and cooperation between state and federal credit union regulators to prevent regulatory and legal barriers to the comprehensive information sharing. This cooperation helps regulators identify and act on issues before they become a problem.--------------------------------------------------------------------------- \2\ 12 U.S. Code 1781(b)(1). \3\ The ``Consultation and Cooperation With State Credit Union Supervisors'' provision contained in The Federal Credit Union Act, 12 U.S. Code 1757a(e) and 12 U.S. Code 1790d(l).--------------------------------------------------------------------------- State regulators play an important role in protecting the safety and soundness of the state credit union system. It is imperative that any regulatory structure preserve state regulators role in overseeing and writing regulations for state credit unions. In addition, it is critical that state regulators and National Credit Union Administration (NCUA) have parity and comparable systemic risk authority with the Federal Deposit Insurance Corporation (FDIC).Q.2. Along with changing the regulatory structure, how can Congress best ensure that regulators have clear responsibilities and authorities, and that they are accountable for exercising them ``effectively and aggressively''?A.2. To ensure a comprehensive regulatory system, Congress should consider the current dual chartering system as a regulatory model. Dual chartering and the value offered to consumers by the state and federal systems provide the components that make a comprehensive regulatory system. Dual chartering also reduces the likelihood of gaps in financial regulation because there are two interested regulators. Often, states are in the first and best position to identify current trends that need to be regulated and this structure allows the party with the most information to act to curtail a situation before it becomes problematic. Dual chartering should continue. This system provides accountability and the needed structure for effective and aggressive regulatory enforcement. The dual chartering system has provided comprehensive regulation for 140 years. Dual chartering remains viable in the financial marketplace because of the distinct benefits provided by each charter, state and federal. This system allows each financial institution to select the charter that benefits its members or consumers the most. Ideally, for any system, the best elements of each charter should be recognized and enhanced to allow for competition in the marketplace so that everyone benefits. In addition, the dual chartering system allows for the checks and balances between state and federal government necessary for comprehensive regulation. Any regulatory system should recognize the value of the dual chartering system and how it contributes to a comprehensive regulatory structure. Regulators should evaluate products and services based on safety and soundness and consumer protection criterion. This will maintain the public's confidence.Q.3. How do we overcome the problem that in the boom times no one wants to be the one stepping in to tell firms they have to limit their concentrations of risk or not trade certain risky products? What thought has been put into overcoming this problem for regulators overseeing the firms? Is this an issue that can be addressed through regulatory restructure efforts?A.3. The current credit union regulatory structure appropriately provides state credit union regulators rulemaking and enforcement authority. This authority helps state regulators respond to problems and trends at state-chartered credit unions and it places them in a position to help state credit unions manage risks on their balance sheets. It is sometimes difficult, particularly during a period of economic expansion to motivate financial institutions to reduce concentration risk when institutions are strongly capitalized and have robust earnings. This is, nevertheless, the appropriate role of a regulator and it is not really a factor that can be addressed through regulatory restructuring. It can only be impacted by having effective, experienced and well trained examiners that are supported in consistent manner by experienced supervisory management.Q.4. As Mr. Tarullo and Mrs. Bair noted in their testimony, some financial institution failures emanated from institutions that were under federal regulation. While I agree that we need additional oversight over and information on unregulated financial institutions, I think we need to understand why so many regulated firms failed. Why is it the case that so many regulated entities failed, and many still remain struggling, if our regulators in fact stand as a safety net to rein in dangerous amounts of risk-taking?A.4. The current economic crisis and resulting destabilization of portions of the financial services system has revealed certain gaps and lapses in overall regulatory oversight. Currently, state and federal regulators are assessing those lapses, identifying gaps, and working diligently to address weaknesses in the system. As part of this process, it is also important to recognize regulatory oversight that worked, whether preventing failure, or identifying undue risk in a manner that allowed for an orderly unwinding of a going concern. To the extent that regulators miscalculated a calibration of acceptable risk, as opposed to undue risk, it may be safe to conclude that undue reliance was placed on underlying market assumptions that failed upon severe market dislocation.Q.5. While we know that certain hedge funds, for example, have failed, have any of them contributed to systemic risk?A.5. NASCUS members do not regulate hedge funds. The answers provided by NASCUS focus solely on issues related to our expertise regulating state credit unions and issues concerning the state credit union system.Q.6. Given that some of the federal banking regulators have examiners on-site at banks, how did they not identify some of these problems we are facing today?A.6. Given NASCUS members regulatory scope, this question does not apply. The answers provided by NASCUS focus solely on issues related to our expertise regulating state credit unions and issues concerning the state credit union system. NASCUS background: The NASCUS, \4\ mission is to enhance state credit union supervision and advocate for a safe and sound credit union system. NASCUS represents the interests of state agencies before Congress and is the liaison to federal agencies, including the National Credit Union Administration (NCUA). NCUA is the chartering authority for federal credit unions and the administrator of the National Credit Union Share Insurance Fund (NCUSIF), the insurer of most state-chartered credit unions.--------------------------------------------------------------------------- \4\ NASCUS is the professional association of state credit union regulatory agencies that charter, examine and supervise the nation's 3,100 state-chartered credit unions.--------------------------------------------------------------------------- Credit unions in this country are structured in three tiers. The first tier consists of 8,088 natural-person credit unions \5\ that provide services to consumer members. Approximately 3,100 of these institutions are state-chartered credit unions and are regulated by state regulatory agencies. There are 27 \6\ retail corporate credit unions, which provide investment, liquidity and payment system services to credit unions; corporate credit unions do not serve consumers. The final tier of the credit union system is a federal wholesale corporate that acts as a liquidity and payment systems provider to the corporate system and indirectly to the consumer credit unions.--------------------------------------------------------------------------- \5\ Credit Union Report, Year-End 2008, Credit Union National Association. \6\ There are 14 state-chartered retail corporate credit unions and 13 federally chartered corporate credit unions.--------------------------------------------------------------------------- ------ CHRG-111shrg50815--50 Chairman Dodd," I appreciate that very much, Senator. We always appreciate that point. It is a worthwhile one. This is an ongoing issue. I just say regarding young people and unsolicited mail, I have a 3-year-old that got a credit card the other day and they wanted to thank her for her wonderful performance as a consumer. She is a delightful consumer, I want you to know that, but the idea that she warrants a credit card at the age of three is troubling, needless to say. And the idea of having some ability to demonstrate you can pay or some cosponsorship, I think these are basic things that one would require. Let me stop there. Senator Johnson? Senator Johnson. Mr. Plunkett, the new Fed rules prohibit banks from increasing interest rates on credit card debt that a consumer has already accrued, increase the amount of time consumers have to make payments, change how a consumer's balance is computed each billing cycle, ensure that consumer payments go first to balances with the highest interest rates, and crack down on credit cards with low credit limits and APs. What other areas would you like to see improvements regarding consumer protections for credit cards? " CHRG-110hhrg46591--65 Mrs. Maloney," Thank you. What I am hearing from my constituents is they are not getting access to credit still, even though it was reported Monday that the credit markets are easing. And these are established businesses, small and large, that are paying their loans on time, yet some banks are pulling their loans. This could be a downward spiral forcing them into bankruptcy, hurting our economy. So I would like to ask Ms. Rivlin, would one approach to help the stability in the credit markets be that at the very least, we could guarantee the loaning between the banks and have a blanket guarantee of new short-term loans to one another by the central banks? Would that be helpful in this regard? We have seen, so far, a piecemeal approach, as has been mentioned by the panelists, and not only in America, but in Europe and Asia as well. This obviously requires a high degree of international cooperation. I welcome your remarks and other panelists on this idea. Would that ease the credit? Would that help us get the credit out to the substantial businesses that are employing paying taxes part of our economy? Ms. Rivlin. I am sorry, a guarantee of interbank lending? Well, that has been discussed. I think we may not need that. It does look as though interbank lending is coming back. And the international cooperation doing the same thing in different financial markets has been actually I think quite impressive that the central banks and treasuries have been working together. So I am not sure that we actually need at this point a guarantee of interbank lending. The interbank lending rates are coming down and the capital injection, it seems to me, is probably going to be enough to do that. " FOMC20051213meeting--47 45,MR. FISHER.," Very quickly, on the Chairman’s question to Karen. Clearly, there is virtue to massive competition. My most delicious irony is the fact that similarly dated Vietnamese debt now trades on a price basis richer, and on a yield basis lower, than that of Ford Motor Company. [Laughter] It wasn’t too long ago that we were killing each other. But we do have, increasingly, an independent central bank in Mexico. We have better reporting techniques in Brazil. And I would submit that while it may not be Anglo-Saxon capitalism, part of this is just a matter of realizing the value of capital and the desire to attract capital. Moreover, the improving at-home conditions make many of these countries increasingly attractive as an alternative. And the competition is good. My question is to David, and maybe Brian or others. I wonder if you could—not now but with some kind of briefing or a paper at some point—give us a sense about the issue you mentioned of the lags in the effects of monetary policy tightening. I’m curious about the dynamics in a tightening scenario such as the FOMC has been pursuing here. How do you calculate the impact and the likely lag time intervals in the progressive process that we’ve been going through as opposed to a December 13, 2005 22 of 100 maybe some of my other colleagues would as well. So it’s not a question to be answered now, but if you’d be kind enough to do that, I’d be grateful. Thank you, Mr. Chairman." FOMC20071211meeting--140 138,MR. KOHN.," Thank you, Mr. Chairman. I support the action and language of alternative B. I think rates are too high right now to support the economy’s remaining near full employment and higher than they need to be to contain inflation. When we left the meeting last time, we thought we might be where we needed to be, but that was premised on a lack of spillovers outside the housing sector and improving financial markets, and both of those have proven not to be the case. So I think we need to move. How much is a tough question. If we were to do 25, we would still have restrictive policy based on the staff forecast because 25 basis points moves the unemployment rate above full employment. So it is still on the restrictive side, even with 25 in the Greenbook. Of course, we would be outrageously tight relative to the markets’ expectations of what we need to do. So I think 25 basis points still leaves us a little on the tight side, and I suspect we will have to do more over time. But I am comfortable doing 25 at this meeting. There is just a huge amount of uncertainty about how the financial markets are evolving, especially before the end of the year. I think we will have a little better sense of what the net deterioration is when we get past the year-end, into January, and see what effect, if any, our auction facility has. Some of the signs we have had in the incoming data haven’t been that negative—the employment report—which is a really key report, and the fact that there is continued growth in employment gives me a little reassurance that we are not in some huge downdraft in the market and that we don’t need to move that aggressively. We do have high headline inflation that we are looking at and some inflation risk. So I think at this point that 25 basis points would send a signal that the Federal Reserve is awake and on the job, and I would stick with language that gives us maximum flexibility, which I think alternative B, section 4, does. President Fisher asked, “What would a decline in the federal funds rate do?” I think it would do quite a bit. It doesn’t address those losses directly, I agree. But I think it would offset some of the tightening in financial conditions or would move in that direction. It would help asset prices. I also asked myself when you asked that question, President Fisher, what would happen if we didn’t lower rates. I think we would have much tighter financial conditions in the market adding to what is already a distressed situation. So I really think that the 25 will be beneficial. A lot of people around the table have said—and President Evans raised the question about whether there are some downside risks—that somehow we could express something more in the statement. I wouldn’t object, Mr. Chairman, if someone found some language to put a little more sense of downside risks about the outlook somewhere in the alternative B statement. Thank you." FOMC20080625meeting--316 314,MR. LACKER.," Yes. I support Governor Warsh's suggestion for raising the price. It is hard for me to believe that confidence in any of these institutions depends materially on 100 basis points of the price. It is the access, the funding, that they would be able to use to fund withdrawal or flight by somebody. I think it sends the right signal that we view this as exceptional. Conditions are certainly different than they were in March, when we designed and implemented it, and I think they are unlikely in the fall to be anywhere close to where they were on March 16. You might disagree, and we could always change things between now and then. But I like the signal of withdrawing the generosity just a tad. " CHRG-110hhrg44901--221 Mr. Bernanke," It is difficult to judge with any certainty. It looks as though the construction activity will begin to stop falling, will begin to bottom out probably later this year or early next year. The more difficult judgment is how much further house prices might decline. There still are significant overhangs of inventories of unsold new homes. I agree absolutely, once there is some confidence that the market has found its level, that there will be considerable improvement in financial conditions and probably a stronger economy as well. " CHRG-111shrg57319--524 Mr. Killinger," Well, Senator, we approved a new strategic plan in actually that summer of 2004, and this is not the whole plan. Remember, this is a small part of our business. But part of that plan was increasing the subprime portfolio that we had in our portfolio over a period of time. But I also was very careful to say that is going to be subject to market conditions and we will be opportunistic. And the reality is we did not execute on that. We ended up shrinking that portfolio that we held, rather than growing it. Senator Coburn. Yes, and this chart actually shows that. " FOMC20081216meeting--224 222,MR. EVANS.," Thank you, Mr. Chairman. As gloomy as our last meeting was, conditions have deteriorated substantially further since then. Practically all of my contacts reported that economic events had turned sharply lower once again in the last three to five weeks. This goes well beyond the auto sector and other parts of the District that have been struggling for some time. The most optimistic comment from my directors was this, ""At least Iowa is going to hell slower than everywhere else."" [Laughter] It is tough to follow that accounting joke, you know--that was good. More seriously, the most optimistic theme I heard from a number of business contacts went something like this, ""We are conserving cash and furiously cutting costs by year-end. But we hope to pause in the first quarter and take stock of where conditions appear to be heading. Then, we will act accordingly."" Frankly, I doubt such a wait-and-see pause in cost-cutting will occur that soon. For the purposes of this meeting and our actions over the next few months, I agree with the main thrust of the Greenbook projection. We are facing large contractions in the next two quarters, and I don't expect to see meaningfully positive growth before the fourth quarter. I think we need substantial further accommodation after today's meeting. I see the timing and the size of those actions for the most part being shaped by the large recessionary forces in train and the enormous financial headwinds. The disinflationary forces in play clearly are strong, but currently I do not expect that they will prove large enough to generate outright deflation. In terms of my earlier question about the Greenbook forecast--as I understand the way it was put together--if the quantitative easing helps, monetary policy would be somewhere between the funds rate at zero and the optimal control. So, in fact, it would be a little better than I first suspected. Inflation would be somewhat above that path. That might be a useful benchmark to watch for if we are fortunate enough for the forecast to be that stable, but time will tell. Quantitative easing should also lead to an increase in the monetary base. I don't know if there was any lasting conflict between your comments and President Lacker's, but I think that what we have contemplated will lead to the base increasing and that will generate expectations about inflation beyond just Taylor-rule dynamics, I would guess. In fact, there is certainly a lot of discussion and criticism out there that our balance sheet is going to lead to large inflationary risks. I don't share that, given how I think we will unwind the programs. But that certainly would help, and it would move us in that direction. So I will keep an open mind on deflationary risk. Thank you, Mr. Chairman. " CHRG-111hhrg67816--129 Mr. Leibowitz," Well, we can't reach--as you know, we can't reach bank issued credit cards, which is about, I think someone said 75 percent. I think it is now probably up to about 95 percent. So a credit card marketing company is simply a non-bank affiliate or surrogate that markets the credit card, and what we found with some of our advance fee cases is they will say you can have a credit card, give us $500, and then when you give them $500 some of it is taken away by fees, by prohibitive monthly costs or you can only use the credit card to buy from their catalog, so those are some of the types of cases we have brought. And then we had a major case involving a company called CompuCredit, which we brought jointly with the banking agencies where they had--and it was a credit card company that actually targeted sub-prime borrowers, people who couldn't otherwise get credit, so that is sort of laudatory at some level. But the credit card limit was $300, and the first month had $185 in fees, which weren't accurately disclosed we alleged, and we had a settlement for $115 million for consumers just the end of last year. That was very, very important for us. Ms. Sutton. OK. So the question that I have though is if a bank is engaging in the exact same activity, can you do anything about it? " CHRG-111hhrg58044--165 Mr. Neugebauer," I think one of my colleagues asked the question and I want to rephrase it just a little bit, is it fair to say that because of the underwriting tools, credit report being one of them, and other information, that people can actually effectively lower their insurance costs by good behavior? " FOMC20060328meeting--291 289,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. I would be comfortable deciding now that we are going to do two-day meetings as a matter of course going forward, even though we may not want to fill the time, in part because I think it’s important to give us time to do special topics as many of you have said. I would generally be in favor of that. And I think we should figure out how to reconcile our director meetings’ calendars with that. I think the idea of separating the discussion about the outlook from policy is a good thing to do, but it’s a little awkward to have these conversations about the forecast without people actually revealing what their conditioning policy assumption is, and it is slightly artificial to separate them completely. So in some sense I think, as the Greenbook does, that we should all take on the obligation in talking about our view of the forecast and the outlook to be a little more explicit about what we think at that stage is the conditioning assumption of the policy. It doesn’t always matter a lot, but it probably does matter. In a two-day meeting, it’s probably good to make sure that we have enough time on the first day that everybody has a chance to do an initial statement. I think chopping it up as we were forced to do today is a little suboptimal. It’s nicer to give everyone a chance to put their basic views on the table at the beginning, and that may require, as Tom said, that we all be a little more selective in how much we say in that initial round. It is in some ways a better basis for give-and-take once people have been able to make their initial statement. Compliments to Dave Stockton for the evolution in the Greenbook presentations of alternative scenarios. I think that, as Dave implied, there’s probably room for further evolution in how the staff structures its contributions to the meetings. As we think about it and as you pointed out, Mr. Chairman, how we think about evolution in our monetary policy regime and our communications regime, we should give some thought at this stage to what kind of supporting material we want to have to underpin that evolution. I think that’s all I’ve got." CHRG-111shrg54675--16 Mr. Templeton," Good afternoon, Chairman Johnson, Ranking Member Crapo, and Members of the Subcommittee. My name is Ed Templeton, and I am here testifying today on behalf of the National Association of Federal Credit Unions. I am President of SRP Federal Credit Union in North Augusta, South Carolina. NAFCU and the entire credit union community appreciate the opportunity to participate in this discussion regarding how the economic crisis has impacted America's credit unions serving in rural communities. While credit unions have fared better than most financial institutions in these turbulent times, many have been impacted, through no fault of their own, by the current economic environment. Credit unions were not the cause of the current economic downturn, but we believe we can be an important part of the solution. Surveys of NAFCU member credit unions have shown that many are seeing increased demand for mortgage and auto loans as other lenders leave the markets. Credit unions have seen small businesses that have lost credit from other lenders turning to credit unions for the capital that they need. Credit unions are meeting those needs specifically in rural areas. NCUA data shows that credit unions have seen a growth in the percentage of the total amount of credit union farm loans for the last nine consecutive quarters. Additionally, the most recent HMDA data shows that credit union mortgage loans to Native Americans increased over the previous year and that credit unions had a higher percentage of approved loans--75.3 percent--than any other type of financial institution. Throughout the country, small credit union roundtables have emerged and engaged in discussions about operations with like institutions. Larger credit unions also serve as partners for the smaller ones and perform functions from shared branching to back-office operations. Credit unions are the most regulated of all financial institutions, facing restrictions on who they can serve and their ability to raise capital, among a host of other limitations. There are small statutory steps Congress can take to enhance the ability of credit unions to serve their members, such as: First, removal of the arbitrary credit union member lending cap. The Credit Union Membership Access Act established an arbitrary cap on credit union member business lending of 12.25 percent in 1998. Many credit unions have available capital that other lenders do not have in this environment, but are hampered by this arbitrary limitation. We are pleased that Senator Schumer has indicated that he plans to introduce legislation to remove this arbitrary cap, and we urge the Subcommittee to support these efforts. Second, underserved areas. As the Subcommittee may be aware, many rural areas are also underserved. Credit unions can play an important role in these communities. The 1998 Credit Union Membership Access Act gave the NCUA the authority to allow Federal credit unions to add underserved areas to their fields of membership; however, the language was unclear as to what types of charters can add underserved areas. NCUA believes that addressing this issue through legislation would clear up this ambiguity, allowing all Federal credit unions to add underserved areas to their fields of membership. Before wrapping up, I would like to make a few comments on the issue of regulatory reform. As not-for-profit member-owned cooperatives, credit unions are unique institutions in the financial services arena. We believe that the NCUA should remain an independent regulator of credit unions and are pleased to see that the administration's proposal would maintain the Federal credit union charter and an independent NCUA. NAFCU supports the creation of a Consumer Financial Protection Agency that would have authority over nonregulated institutions that operate in the financial services marketplace. However, we do not support extending that authority to federally insured credit unions, given that the CFPA has authority to regulate, examine--or would have authority to regulate, examine, and supervise credit unions that are already regulated by the NCUA, which would add an additional burden and cost to credit unions. Recognizing that more should be done to help consumers, we propose that each functional regulator establish or strengthen a new office on consumer protection. We believe that such an approach would strengthen consumer protection while not adding unnecessary regulatory burdens on our Nation's credit unions. We are pleased to see that NCUA Board Chairman Mr. Michael Fryzel recently announced the creation of such an office at NCUA. In conclusion, the current economic crisis is having an impact on credit unions in rural areas, but we are continuing to serve our members well. As an illustration, we at SRP Federal Credit Union are actually expanding at this time into one of the most rural areas within our field of membership. We are about to break ground on a new branch in Allendale County, South Carolina. The county has a population of 10,477 and an unemployment rate of 22.1 percent. We urge the Subcommittee to support efforts to remove the credit union member business lending cap and to clarify the ability of credit unions of all charter types to add underserved areas. Finally, while there are positive aspects to consumer protection in regulatory reform, we believe that Federal credit unions continue to warrant an independent regulator that handles both safety and soundness and consumer protection matters. I thank you for the opportunity to appear before you today on behalf of NAFCU and our country's credit unions, and I would welcome any questions you may have. " CHRG-110hhrg41184--21 Mrs. Biggert," Thank you, Chairman Bernanke, for your continued efforts to keep our economy growing. And I'd like to thank you for the Federal Reserve's thorough analysis of the debt level of the American families and for promulgating rules relating to high cost mortgages and credit cards. As you know, this committee continues to address issues related to the mortgages and to the credit cards, and I have concerns about some of the legislation before this committee that may cause a further tightening in the credit market. So I would like to just ask you a couple of questions based on credit cards. And based on the Fed's recent surveys and studies, what do consumers need to know to make informed decisions about their credit cards? And could you just describe briefly the Regulation Z and what you believe it will do to help consumers better understand the terms of their credit card agreements? And when do you anticipate, I think you said this spring, that the regulation will be finalized? And, finally, can you discuss actions that the Fed plans to take and when to crack down on unfair and deceptive practices of bad actors in the credit card industry? In 2 minutes, probably. " FinancialCrisisReport--271 In 2005, in its 11th Annual Survey on Credit Underwriting Practices, the Office of the Comptroller of the Currency (OCC), which oversees nationally chartered banks, described a significant lowering of retail lending standards, noting it was the first time in the survey’s history that a net lowering of retail lending practices had been observed. The OCC wrote: “Retail lending has undergone a dramatic transformation in recent years as banks have aggressively moved into the retail arena to solidify market positions and gain market share. Higher credit limits and loan-to-value ratios, lower credit scores, lower minimum payments, more revolving debt, less documentation and verification, and lengthening amortizations - have introduced more risk to retail portfolios.” 1048 Starting in 2004, federal law enforcement agencies also issued multiple warnings about fraud in the mortgage marketplace. For example, the Federal Bureau of Investigation (FBI) made national headlines when it warned that mortgage fraud had the potential to be a national epidemic, 1049 and issued a 2004 report describing how mortgage fraud was becoming more prevalent. The report noted: “Criminal activity has become more complex and loan frauds are expanding to multitransactional frauds involving groups of people from top management to industry professionals who assist in the loan application process.” 1050 The FBI also testified about the problem before Congress: “The potential impact of mortgage fraud on financial institutions and the stock market is clear. If fraudulent practices become systemic within the mortgage industry and mortgage fraud is allowed to become unrestrained, it will ultimately place financial institutions at risk and have adverse effects on the stock market.” 1051 In 2006, the FBI reported that the number of Suspicious Activity Reports describing mortgage fraud had risen significantly since 2001. 1052 1047 “Housing Bubble Concerns and the Outlook for Mortgage Credit Quality,” FDIC Outlook (Spring 2004), available at http://www.fdic.gov/bank/analytical/regional/ro20041q/na/infocus.html. 1048 6/2005 “Survey of Credit Underwriting Practices,” report prepared by the Office of the Comptroller of the Currency, at 6, available at http://www.occ.gov/publications/publications-by-type/survey-credit-underwriting/pub- survey-cred-under-2005.pdf. 1049 “FBI: Mortgage Fraud Becoming an ‘Epidemic,’” USA Today (9/17/2004). 1050 FY 2004 “Financial Institution Fraud and Failure Report,” prepared by the Federal Bureau of Investigation, available at http://www.fbi.gov/stats-services/publications/fiff_04. 1051 Prepared statement of Chris Swecker, Assistant Director of the Criminal Investigative Division, Federal Bureau of Investigation, “Mortgage Fraud and Its Impact on Mortgage Lenders,” before the U.S. House of Representatives Financial Services Subcommittee on Housing and Community Opportunity, Cong.Hrg. 108-116 (10/7/2004), at 2. 1052 “Financial Crimes Report to the Public: Fiscal Year 2006, October 1, 2005 – September 30, 2006,” prepared by the Federal Bureau of Investigation, available at http://www.fbi.gov/stats- services/publications/fcs_report2006/financial-crimes-report-to-the-public-2006-pdf/view. CHRG-111hhrg58044--322 STATEMENT OF ANNE P. FORTNEY, PARTNER, HUDSON COOK, LLP Ms. Fortney. Thank you. I am Anne Fortney, a partner in the Washington, D.C., office of the Hudson Cook law firm. I appreciate the opportunity to appear before you again today. My testimony draws on many years of consumer protection practice in both the private and the public sectors, including service at the Federal Trade Commission. I believe my depth of experience enables me to comment upon legislation from the perspective of consumers, as well as the consumer financial services industry. I am aware that credit information is used as a factor in predicting risk other than consumers' default on credit obligations, such as when it is used in insurance and employment purposes. Credit information is used in conjunction with other empirical information for these purposes, because it has been proven to be a reliable tool in predicting risk. While some may question the use of credit histories in employment situations, there are times when that information is essential to a prospective employer or licensor. In fact, to protect consumers, many States require credit information in evaluating applicants for mortgage loan originator licenses. As the Fair Credit Reporting Act recognizes, it is critical that consumer reports used for employment decisions be accurate. To that end, the law requires notice to a consumer before any adverse action based on a consumer report is taken. As a result, an employment decision is not made until the consumer is alerted to negative information in the report, and has the opportunity to correct any inaccurate information. A consumer will also receive notice if the consumer report information formed a basis for the denial of employment, or for another decision that affects the consumer, once employed. My previous testimony before this subcommittee addressed the use of medical debt collection information in credit histories. As others have testified, this information is a predictive characteristic in credit scoring systems. For that reason, its use benefits consumers, as well as creditors and others that rely upon that information. In 2003, Congress enacted FCRA subsection 615(h)(8), which eliminated a consumer's private right of action for all violations occurring under section 615. Since then, litigants across the country have argued about whether Congress intended to eliminate this private right of action, or whether there was a so-called scrivener's error that led to this result. Some critics complain that there was no legislative history evidencing the congressional intent to achieve this result. However, the lack of legislative history is irrelevant. Because of the haste with which Congress deliberated and enacted the amendments to the FCRA at the end of 2003, there is a dearth of legislative history on any of the provisions. Moreover, some claim that the placement of the private right of action exclusion within this subsection is indicative of the congressional intent to limit its application to that particular subsection. However, that claim is not supported by anything in the legislative record. At this point in time, rather than trying to discern what Congress may or may not have intended more than 6 years ago, I believe the appropriate inquiry is whether Congress should now reinstate a private right of action. Based upon my experience with the FCRA, and my participation as an expert witness in class action litigation arising under this subsection, I do not believe that there is any measurable benefit for consumers in reinstating a private right of action for its violations. There is no indication that consumer report users routinely fail to comply with the section 615 adverse action notice requirements since the elimination of the private right of action. The National Consumer Law Center's written testimony mentions 44 cases in which it claims to have alleged consumer reports users' failure to give an adverse action notice. In fact, virtually all those cases involved a different allegation, usually that creditors gave consumers a notice, as required, but the notice was not clear and conspicuous. In other words, the section 615 claim in those cases was that, although consumers received the proper notice, it was not in the proper type size. The courts rightly saw those claims as blatant attempts to extract huge statutory damages in class action suits where there was no consumer harm. There is no indication that the Federal agency or State attorneys general administrative enforcement of section 615 is inadequate. At the same time, as described in my written statement, history shows that the only persons who stand to benefit from the reinstatement of a private right of action under section 615 are those lawyers who can pursue class action litigation, unless Congress also implements appropriate limits on class action liability. Otherwise, consumers will ultimately be the ones who bear the cost of litigation in the form of increased credit and insurance rates. Thank you for the opportunity to testify. I will be glad to answer your questions. [The prepared statement of Ms. Fortney can be found on page 67 of the appendix.] " FOMC20050503meeting--95 93,VICE CHAIRMAN GEITHNER.," Thank you, Mr. Chairman. We think the fundamentals underpinning a forecast of a reasonably strong expansion with moderate inflation seem reasonably persuasive. However, we are less confident than we were at the last meeting. On the assumption that we continue to move the fed funds rate higher on a path close to that now in the market, we expect the economy to grow at a 3½ percent rate during the balance of this year and in 2006. And we still expect core PCE inflation to come in below 2 percent, although just below, over the balance of the forecast period, but we think it will follow a somewhat higher path. As this implies, we’re very close to the Greenbook projection on the overall contour of the forecast, and we’re close on the components as well. We see greater uncertainty in the forecast, with some downside risk to growth and some upside risk to inflation. We think the probability of inflation coming in higher is greater than the probability that growth will be lower. And, of course, that judgment about the change in relative May 3, 2005 56 of 116 On the growth front, the anecdotal reports we’re exposed to are weaker than they have been. They’re weaker than the national numbers and may imply some further deceleration ahead. We don’t have much basis for confidence that these numbers tell us much about the future, but the sentiment does seem a bit more fragile. The fact that confidence seems to have eroded so quickly in the face of a relatively limited period of weaker numbers might itself suggest greater vulnerability to the forecast. Despite all of this, though, we think the near-term fundamentals of the economy look fairly good. The resilience of the recent past seems likely to be durable. We think the labor market still looks to be on a path of gradual improvement. Investment growth still seems likely to be pretty healthy, with profit margins high, balance sheets strong, and credit conditions favorable. We think the factors supporting solid investment growth remain compelling. And we still are inclined to believe that structural productivity growth is likely to remain strong, which should provide both continued impetus to investment and continued confidence about future income growth. It’s hard to find other constraints out there that could limit the expansion. Of course, we still face some risk of an abrupt change in household saving behavior, and the effects of that could be significant. On the inflation front, we’ve been surprised by the extent of the acceleration in core prices and we are a bit concerned about the higher expectations reflected in some surveys. The economy is growing at a rate that seems likely to be sufficient to continue to absorb remaining slack, unit labor costs have moved up, and we hear continued reports of increased pricing power. And some measures of expectations at the intermediate horizon—the horizon over which we expect monetary policy can affect inflation—are above the desirable level of inflation. Accordingly, we see greater risk that inflation will follow a higher path than we are comfortable with. This seems a prudent view May 3, 2005 57 of 116 has been modest to date—profit margins remain very high, of course—and despite expectations of fairly good future structural productivity growth. The modest widening in credit spreads and the volatility in equity prices we’ve seen recently have been absorbed reasonably well. I’d be inclined to view this modest repricing of risk and uncertainty as welcome and healthy rather than as foreshadowing a deeper, more protracted deceleration. On balance, we believe that monetary policy should continue to be directed at moving the real fed funds rate higher. At our last meeting we introduced a bit more uncertainty into the monetary policy signal by putting in more qualifications about the likely path of monetary policy going forward and about the cumulative amount of tightening. The overall effect of these changes to our statement was to continue to signal that we think the slope of the funds rate path remains positive, implying, of course, that monetary policy is still too accommodative. But we also indicated, through these changes to this statement, that we have less certainty about the slope and shape of that path. Long-term measures of inflation expectations moderated immediately following the meeting, and some measures of uncertainty about future rates went up. And since then, market participants have demonstrated a very significant degree of sensitivity to incoming data—at least in terms of the fed funds path priced into the markets To me this suggests that we got the balance about right last time. We bought ourselves the desirable increase in flexibility to respond to a somewhat more uncertain set of conditions going forward, and I think we should try to preserve that balance in our signal today. We need to acknowledge, of course, the moderation in the rate of growth in output and demand we’ve seen and the higher inflation numbers, but I don’t see a good reason to try to alter May 3, 2005 58 of 116 The increased uncertainty in the market about the forecast reflects some greater dispersion in the likely path of the fed funds rate, and I think it suggests little gap between the market’s view and our own view of policy uncertainty going forward. So I don’t see a case for altering the statement significantly today in a way that would introduce a greater degree of uncertainty about monetary policy than is already reflected in the markets at this point. Thank you." fcic_final_report_full--453 The shadow banking business . The large investment banks—Bear, Lehman, Merrill, Goldman Sachs and Morgan Stanley—all encountered diffi culty in the financial crisis, and the Commission majority’s report lays much of the blame for this at the door of the Securities and Exchange Commission (SEC) for failing adequately to supervise them. It is true that the SEC’s supervisory process was weak, but many banks and S&Ls—stringently regulated under FDICIA—also failed. This casts doubt on the claim that if investment banks had been regulated like commercial banks— or had been able to offer insured deposits like commercial banks—they would not have encountered financial diffi culties. The reality is that the business model of the investment banks was quite different from banking; it was to finance a short-term trading business with short-term liabilities such as repurchase agreements (often called repos). This made them especially vulnerable in the panic that occurred in 2008, but it is not evidence that the existence of investment banks, or the quality of their regulation, was a cause of the financial crisis. Failures of risk management . Claims that there was a general failure of risk management in financial institutions or excessive leverage or risk-taking are part of what might be called a “hindsight narrative.” With hindsight, it is easy to condemn managers for failing to see the dangers of the housing bubble or the underpricing of risk that now looks so clear. However, the FCIC interviewed hundreds of financial experts, including senior offi cials of major banks, bank regulators and investors. It is not clear that any of them—including the redoubtable Warren Buffett—were suffi ciently confident about an impending crisis that they put real money behind their judgment. Human beings have a tendency to believe that things will continue to go in the direction they are going, and are good at explaining why this must be so. Blaming the crisis on the failure to foresee it is facile and of little value for policymakers, who cannot legislate prescience. The fact that virtually all participants in the financial system failed to foresee this crisis—as they failed to foresee every other crisis—does not tell us anything about why this crisis occurred or what we should do to prevent the next one. 1 See, e.g., Peter J. Wallison, “Deregulation and the Financial Crisis: Another Urban Myth,” Financial Services Outlook , American Enterprise Institute, October 2009. 447 CHRG-111hhrg53242--50 Mr. Baker," I would not characterize it quite that way. I won't attempt to argue your perspective relative to AIG. I will say that there were other circumstances that contributed mightily to their demise. But if I may, by way of best response, give you an example of concern I would have with regard to the legislation, and then quickly add there are things we can do that would help with your concerns relative to transparency, relative to centralized clearing, exchanges, collateral segregation, enhanced regulatory authorities, I think we can get to the safe point you would wish to go. But let me give the quickest, shortest example of the concern I have that I think you will find as a legitimate validating reason. If there is a pension who has a variety of investments, and let's just call one portfolio a technology-heavy, long-only type of investment strategy. But the pension is worried about having to meet its monthly flat obligations to write those pension checks. We all know there has been extreme volatility in the markets. The pension then wants to protect against that volatility in that technology portfolio. They turn around to a bank and say, we would like to buy credit index protection from you. No need to get into the definition, but it is a way to hedge against the volatility in that broad price swing of those technology stocks, enabling them for a small cost to make those monthly payments to retirees. Not only is that a credit default swap product, it could be defined--and I worry about this--as a naked credit default swap, and here is why: The pension might have 20 technology stocks in that portfolio. When you buy the credit index protection, it might have 100 companies in it, and you would have no underlying relationship, no bond, no debt, nothing with those 80 firms. And technically, if Congress would move ahead in this regard, you might preclude the pension from getting access to the credit index protection. It even gets worse. Because the bank then, because of regulator pressure, wanting to lower its risk profile, will turn that credit index exposure over to a hedge fund. The hedge fund will buy it and then perhaps need to go long on technology stocks because it just shorted the credit index. Amazing as it may sound, people will go buy IBM stock and then turn around and at the same time go short Apple. Now, it is not because they believe Apple is going to go south tomorrow and they are actually doing predatory shorting. They are doing it because they might be wrong on the long side on IBM, but since they have strong belief in the technology sector, they cover both ways. Hence, the definition of hedge fund. We can provide a lot more technical analysis to your staff. The SEC's Office of Risk Analysis has some really good work on the contributing causes to AIG's demise, and I think it would be very helpful in the appropriate context to have that made available to you. Ms. Waters. You see what I meant about Mr. Baker? He just gave us a lesson in credit default swaps and indexes that we probably have not even discussed before. I thank you very much. Let me just complete my remarks by saying I am interested in trying to find out who benefits from bankruptcy with these credit default swaps. " FOMC20080130meeting--176 174,MR. PLOSSER.," Thank you, Mr. Chairman. You know, listening to the staff discussion I have certainly come to understand why everyone continues to believe that economics is a dismal science. [Laughter] It is quite a dismal picture. But more seriously, recent economic data have certainly helped feed that view, and the Third District is no exception. Economic activity has weakened in our District since December, and to double the fun, firms continue to face increasing price pressures--not a very comfortable position for monetary policymakers. The Philadelphia staff's state coincident indicators indicate that overall economic activity has been moderate in New Jersey, flat in Pennsylvania, and declining in Delaware over the past three months. Our Business Outlook Survey of manufacturers fell sharply in January. The index fell to minus 20.9 from minus 1.6 in December. Now, some of that we have to remember is sentiment, in the sense that the question has to do with general activity and doesn't necessarily reflect just their firm. But it is a sentiment of pessimism that certainly is more prevalent than it once was. A reading that low, of minus 20, indicates declining manufacturing activity in the region and is usually associated with very low GDP growth or perhaps even negative GDP growth at the national level. More related to the firms' own performance, though, the survey's indexes of new orders and shipments also declined in January, and both are now in negative territory, although much less so than the general activity index. On the other hand, while expectations of activity six months from now have moved down somewhat this month, they remain firmly in positive territory, and firms' capital spending plans over the next six months remain relatively strong. District bankers are reporting weaker consumer loan demand, but business lending continues to advance at a moderate pace from their perspective. Loan quality has shown slight deterioration, mainly in residential real estate and auto loans, to a lesser extent in credit cards, and to an even lesser extent on the business loan side. This downtick in quality follows a period of extraordinarily low delinquencies and default rates and thus is well within historical norms, so it has not greatly alarmed our banking community. Thus far, our District banks apparently have largely escaped the credit problems plaguing the larger money center banks and investment banks. While there has been some tightening in credit conditions and standards around the District, most non-real-estate-related firms I spoke with are not finding it difficult to obtain credit for any reasonable project they want to do, and so they have not identified largely with the credit crunch scenario. Despite the softness in the activity, firms in our District report higher prices in their inputs and outputs. As President Lacker said, inflation seems to be alive and well. The current prices-paid and prices-received indexes in our Business Outlook Survey accelerated sharply in January and are at very high levels, almost record levels, of the past twenty years. Firms also expect prices to rise over the next six months. These forward-looking price indexes, too, are at very elevated levels relative to their twenty-year history. I am hearing from business contacts and from one of my directors, for example, that they are planning to implement price increases to pass along costs they are experiencing. Thus, even though they are pessimistic about growth in the future, they are not pessimistic about price increases. This adds to my skepticism about arguments that link inflation too closely with resource utilization. The national near-term economic outlook is also deteriorating, as we have been hearing, and I have revised down my growth forecast for 2008 compared with my October submission. It is hard to find much positive news in the data released since our last meeting, and the Board staff has summarized that quite eloquently, and so I won't repeat them. Nevertheless, in general, my forecast is probably slightly less pessimistic than the Board's forecast. However, I must add that, at the same time that growth has slowed, inflation has trended up. Both the core CPI and the core PCE accelerated in the second half of '07, compared with the first half. The core CPI advanced at a 2.6 percent rate in the second half of '07, compared with a 2.3 percent rate in the first half, and the core PCE was up at a 2.4 percent rate in the second half compared with 1.9 in the first half. As we know, the PCE price index gets revised. Recent research by Dean Croushore, one of our visiting scholars, has shown that between 1995 and 2005 the average revision from initial release until the August release the following year was positive on average for both the core PCE and the total PCE. This suggests that inflation is likely to be even higher in the second half of '07 than the current estimates indicate. I am also concerned that, over the past 10 year period, core and headline inflation for both the PCE and the CPI have diverged on average about 50 basis points. Headline rates have exceeded core rates in 8 of the last 10 years for the CPI and 9 out of the last 10 years for the PCE. While I would like to believe that these two rates should be converging on average, I am concerned that core rates may not be as indicative of underlying trend inflation as we might have thought. This line of thinking also leads me to question estimates of ex post real funds rates calculated by the staff and presented in the Bluebook, which are based on subtracting core PCE from the nominal funds rate. I am not convinced that the core PCE is the right measure of inflation in this context. Even if you thought it was, then the reported real rates are likely to be overstated for recent quarters given the apparent systematic bias in the preliminary estimates of the PCE that I have noted before. Moreover, some measures of inflation expectations are not encouraging: In particular, the Michigan survey one-year-ahead measures and five-year-ahead measures are up. We have already discussed a bit the acceleration in some of the TIPS measures. I will return to that in a minute. The Livingston survey participants have also raised their forecast for CPI inflation in 2008 from 2.3 percent to 3 percent. My forecast overall is similar to the Greenbook's, and I expect a weak first half and a return toward trend growth later this year and into '09 and inflation at the 1.7 to 2 percent range. But the policy assumptions that I make to achieve the forecasted outcomes for the intermediate term are different from the Greenbook's. The ongoing housing correction and poor credit market conditions are a significant drag in the near term on the economy, and I expect growth in the first half of the year to be quite weak, probably around 1 percent. As conditions in the housing and financial markets begin to stabilize, I expect economic growth to improve in the second half of the year and move back toward trend, which I estimate to be about 2� percent, about 50 basis points higher than the Greenbook, I think, in 2009. The slowdown in real activity suggests a lower equilibrium real rate. How much lower is difficult to measure with any precision. Ten-year TIPS have fallen about 100 basis points since the beginning of September. In such an environment, optimal policy calls for the FOMC to allow the funds rate to fall as well. And we have; the funds rate is down 175 basis points since September--or more if we cut today. But we also must remain committed to delivering on our goal of price stability in this environment of rising prices. To my mind, that means we must continue to communicate that commitment to the markets and to act in a manner that is consistent with that commitment. I want to stress that while many of us, myself included, have argued that inflation expectations remain well anchored, we cannot wait to act until we see contrary evidence to such a claim because by then it will be too late and we will have already lost some credibility. I also might add that the staff memo on inflation compensation, which I thought was very good, suggests that one reason for the increase in forward inflation compensation might be a greater inflation risk premium rather than a rise in expected inflation. That may, in fact, be true, and I think the memo was very well done. But if that is the case, if the rise is in the inflation risk premium, then I think it might be worth asking ourselves if the increase in inflation uncertainty might be an early warning sign of our waning credibility. This perspective leads me to a different policy assumption from the Greenbook's. In particular, once the real economy is stabilized, the FOMC must act aggressively to take back the significant easing it has put in place in order to ensure that inflation is stabilized in 2010. Employment is a lagging indicator, so we will likely have to act before employment growth returns to trend, should output growth pick up in the second half of the year as forecasted. Thus, I expect we will need to begin raising rates by the fourth quarter of this year and perhaps aggressively so. In contrast, the Greenbook assumes a flat funds rate at 3 percent throughout the forecast period. Despite the real funds rate remaining below 1 percent--and well after the economy has returned to trend growth--inflation expectations remain anchored in the Greenbook. In my view, this seems somewhat implausible or, at best, a very risky bet. It appears that the Greenbook achieves this result through an output gap--related to the question I was asking earlier this afternoon. I think all of us understand the very real concerns that many researchers have with our ability to accurately estimate the level of potential GDP. Furthermore, in the recent research on inflation dynamics that we have discussed--and President Yellen was referring to this--inflation becomes less persistent and appears to be less related to other macroeconomic variables as well. We do not know whether these changes are an outcome of a more aggressive and credible stance of monetary policy against inflation or are due to some fundamental changes in the world economy. If the lower persistence is due to enhanced policy credibility, then it is incumbent upon this Committee to maintain that credibility. Otherwise, we cannot expect inflation persistence to remain low. Thus, if the economy performs as forecasted on the growth side, with a return toward trend growth in the second half, I would be very uncomfortable leaving a real funds rate below 1 percent. The Bluebook scenarios involving risk management indicate that the inflation outcome is poor when there is a gradual reversal of policy. Better outcomes are achieved under a prompt reversal strategy. Given that forecast, I believe we must begin thinking now about what our exit strategy from this insurance we have put in place is going to be. How we communicate our monetary policy strategy will also be crucially important because of the effects such communications will have on expectations. We need to better understand in our own minds, I think, what our reaction function looks like so that we can be more systematic and articulate in our implementation of policy. Thank you. " fcic_final_report_full--14 Finally, when the housing bubble popped and crisis followed, derivatives were in the center of the storm. AIG, which had not been required to put aside capital re- serves as a cushion for the protection it was selling, was bailed out when it could not meet its obligations. The government ultimately committed more than  billion because of concerns that AIG’s collapse would trigger cascading losses throughout the global financial system. In addition, the existence of millions of derivatives con- tracts of all types between systemically important financial institutions—unseen and unknown in this unregulated market—added to uncertainty and escalated panic, helping to precipitate government assistance to those institutions. • We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction. The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors re- lied on them, often blindly. In some cases, they were obligated to use them, or regula- tory capital standards were hinged on them. This crisis could not have happened without the rating agencies. Their ratings helped the market soar and their down- grades through 2007 and 2008 wreaked havoc across markets and firms. In our report, you will read about the breakdowns at Moody’s, examined by the Commission as a case study. From  to , Moody’s rated nearly , mortgage-related securities as triple-A. This compares with six private-sector com- panies in the United States that carried this coveted rating in early . In  alone, Moody’s put its triple-A stamp of approval on  mortgage-related securities every working day. The results were disastrous:  of the mortgage securities rated triple-A that year ultimately were downgraded. You will also read about the forces at work behind the breakdowns at Moody’s, in- cluding the flawed computer models, the pressure from financial firms that paid for the ratings, the relentless drive for market share, the lack of resources to do the job despite record profits, and the absence of meaningful public oversight. And you will see that without the active participation of the rating agencies, the market for mort- gage-related securities could not have been what it became. * * * T HERE ARE MANY COMPETING VIEWS as to the causes of this crisis. In this regard, the Commission has endeavored to address key questions posed to us. Here we discuss three: capital availability and excess liquidity, the role of Fannie Mae and Freddie Mac (the GSEs), and government housing policy. First, as to the matter of excess liquidity: in our report, we outline monetary poli- cies and capital flows during the years leading up to the crisis. Low interest rates, widely available capital, and international investors seeking to put their money in real estate assets in the United States were prerequisites for the creation of a credit bubble. Those conditions created increased risks, which should have been recognized by market participants, policy makers, and regulators. However, it is the Commission’s conclusion that excess liquidity did not need to cause a crisis. It was the failures out- lined above—including the failure to effectively rein in excesses in the mortgage and financial markets—that were the principal causes of this crisis. Indeed, the availabil- ity of well-priced capital—both foreign and domestic—is an opportunity for eco- nomic expansion and growth if encouraged to flow in productive directions. Second, we examined the role of the GSEs, with Fannie Mae serving as the Com- mission’s case study in this area. These government-sponsored enterprises had a deeply flawed business model as publicly traded corporations with the implicit back- ing of and subsidies from the federal government and with a public mission. Their  trillion mortgage exposure and market position were significant. In  and , they decided to ramp up their purchase and guarantee of risky mortgages, just as the housing market was peaking. They used their political power for decades to ward off effective regulation and oversight—spending  million on lobbying from  to . They suffered from many of the same failures of corporate governance and risk management as the Commission discovered in other financial firms. Through the third quarter of , the Treasury Department had provided  bil- lion in financial support to keep them afloat. CHRG-111hhrg48873--194 Mr. Bernanke," They would not be disadvantaged necessarily--well, they would in the following sense: the concern is that if banks were revealed to be borrowing and others were not, inference might be drawn that they were in weaker condition than they, in fact, might be. The problem is what is called stigma, so that if banks are being perceived as weaker, if they have to come to the Fed, then others might not wish to deal with them, and they might not come to the Fed. In fact, that was the problem we had at the beginning of this episode, that no one wanted to come borrow, even though it was clear that the banking system needed to get liquidity from us. So we have tried to make sure that their information is protected so they will, in fact, come and take the liquidity they need-- " FOMC20081216meeting--60 58,MR. MADIGAN.," 2 The staff provided eight questions to help frame your discussion, and those questions are included in the package we have placed before you--a single page with a blue cover sheet. I would like to comment briefly on each of them. The first question deals with the issue of whether policy adjustments should be accelerated when the zero bound looms, as the research literature indicates, or whether the Committee should ""keep its powder dry""--for example, if it believes that the announcements of rate cuts have some special ability to buoy confidence. In present circumstances, a key practical consideration is that the System's liquidity programs have already resulted in a very low effective federal funds rate. Absent a very substantial unwinding of those facilities, the effective funds rate will remain close to zero for the foreseeable future even if the Committee adopts a significantly positive target for the federal funds rate. Still, the announcement of cuts in the target rate probably would trigger further reductions in the prime rate and thus in rates paid by a sizable fraction of debtors. Alternatively, the Committee might set a target rate significantly above zero to convey its intentions for the stance of monetary policy over a period longer than the intermeeting period. The second question concerns your views of the costs of very low interest rates. In the financial markets, very low short-term rates are likely to erode liquidity; fails will increase, and the returns available on some short-term investments simply will not overcome the transaction costs. The staff research concluded that certain financial intermediaries, such as Treasury-only money market funds, will clearly be adversely affected by very low interest rates, and those adverse effects could have spillover effects into other markets, such as the repo market. But not all financial institutions will be hurt by low rates; there will be winners and losers, depending partly on their asset�liability mix. Moreover, our work suggested that financial institutions in the aggregate tend to benefit from the macroeconomic stimulus of monetary policy easing. Overall, judging the point at which the marginal costs of rate reductions exceed the marginal benefits is quite difficult. The third question asks whether you see a net benefit from communicating your intentions for inflation beyond the next few years or your views about the likely stance of monetary policy over some period longer than the intermeeting period. Specifically, we suggested that you comment on the desirability of stating (1) that you intend to hold the funds rate at very low levels until specified conditions prevail, (2) that the Committee is concerned about the risks of excessive disinflation and will act to mitigate that risk, or (3) that the Committee will be willing to temporarily accept higher rates of inflation in the next few years in order to limit the economic downturn 2 The materials used by Mr. Madigan are attached to this transcript (appendix 2). and encourage recovery. The draft statements presented in the ""Policy Alternatives"" section of the Bluebook include language that you might consider if you decide to pursue one or more of these possibilities. Questions 4 through 8 cover nonstandard policy tools. Question 4 asks your views about the benefits of large open market operations in agency debt, agency MBS, and Treasury securities. Such purchases are clearly within the authority of the FOMC, and the staff research suggests that they have definite potential to stimulate economic activity by lowering longer-term interest rates, although calibrating those effects is difficult. However, members could be troubled by the fact that purchases of agency debt and MBS could be regarded as steering funds to the GSEs and to particular economic sectors. In your responses to this question, you may want to comment on whether you are concerned by the credit-allocation aspects of such purchases. You may also want to provide your views on the channels through which purchases of Treasuries or agency securities would have a beneficial effect. In particular, do you see the power of such tools as arising from their effects in reducing long-term yields and spreads and supporting aggregate demand through those channels? Or would you emphasize the increase in excess reserves and the monetary base that would accompany such purchases and the possible effects on bank lending? Question 5 relates to liquidity facilities. As Steve noted, the creation of additional lending facilities is another potentially powerful policy tool for the Federal Reserve-- particularly in current circumstances, in which credit flows in some markets are severely disrupted. Some of those facilities appear to have been successful in supporting credit flows and thus economic activity. But even though further additions or expansions could be helpful to credit intermediation, taking these steps would involve a number of substantive issues. Also, the design, implementation, and ongoing operation of such facilities pose real resource challenges to the System. Moreover, these programs raise governance issues. Because such programs generally rely on the section 13(3) lending authority, authorization of these programs is the responsibility of the Board, and the decision to lend is made by the Reserve Bank. At the same time, these programs create reserves and thus potentially affect the FOMC's ability to influence the funds rate. Question 6 is open-ended: Do you see other nonstandard policy tools besides open market purchases and liquidity facilities as likely to be particularly helpful in current circumstances? If so, what are those tools? Question 7 returns to governance issues: Given that the Desk has begun to purchase agency debt and MBS, how should the FOMC specify its directive to the Desk? If the Committee instructed the Desk to undertake purchases in order to attain specific objectives for interest rate levels or rate spreads, serious practical issues could arise. Longer-term yields are heavily affected by expectations of future policy rates, which are in turn importantly driven by incoming economic news as well as by various risk premiums. Experience indicates that our operations have an effect on longer-term yields, but to have an effect that is economically significant, the operations may need to be very large. Even then, given the substantial effects of the other factors that affect yields, it might be very difficult or impossible to achieve specified rate levels or spreads. As an alternative, the Committee could instruct the Desk to purchase specific quantities of particular types of obligations. Such an approach is clearly feasible, but its potential benefits may be harder to communicate to the public except in qualitative terms. Another issue is whether the directive should be conditional on market developments. The Bluebook provided drafts of directives in which the basic approach is to specify quantities of purchases over specified periods of time but with some allowance for qualitative judgments about market conditions. Question 8 comes back to communication issues. If the Committee embarks on the use of unconventional policy tools, clearly communicating the nature of the policy and the intended objectives will be challenging. For example, once the Committee has formally brought its target for the federal funds rate to around zero or otherwise has signaled that further rate reductions will not be forthcoming, there will surely be press stories asserting that the Committee has ""run out of ammunition,"" potentially undermining the Committee's message that monetary policy still can provide considerable stimulus. Overcoming these communication challenges will be somewhat easier if the Committee is able to agree on the substance of what it is trying to accomplish and a broad approach to explaining it to the public. But achieving such agreement is complicated by significant remaining uncertainties about the effectiveness of the various unconventional policy tools, a very uncertain economic outlook, and other factors. In your remarks, you may wish to provide your views of the best practical means for the Committee to address these communication challenges. Thank you. We would be happy to respond to your questions. " CHRG-111hhrg51698--624 Submitted Statement of National Grain and Feed Association The National Grain and Feed Association (NGFA) appreciates the opportunity to submit the following statement for the record of the Committee's hearing on draft legislation titled the ``Derivatives Markets Transparency and Accountability Act of 2009.'' The NGFA is the national association representing about 950 companies in the grain, feed and processing industry and related commercial businesses. The NGFA's member companies operate more than 6,000 grain handling and processing facilities nationwide. These companies are the traditional users of U.S. agricultural futures markets like the Chicago Board of Trade, the Kansas City Board of Trade, and the Minneapolis Grain Exchange. The NGFA's members rely heavily on products traded on regulated exchanges for price discovery and to manage their price and inventory risks. Properly functioning contracts and transparent markets are of the utmost importance. For these reasons, the NGFA's input on the draft bill goes more directly to futures market-related provisions than to proposed changes in the regulation of derivative products.Contract Performance and Impact of Investment Capital The NGFA and its member firms have been extremely concerned during the last 3 years about performance of the CBOT wheat contract. We believe strongly that participation of investment capital in the CBOT wheat contract--a fairly recent phenomenon that has reached significant levels--has contributed to a disconnect between cash prices and futures prices on-exchange. This disconnect has made it difficult and costly for grain hedgers to rely on the soft wheat contract for hedging purposes and efficient pricing and has contributed to soft wheat basis behaving in ways that would not be expected historically. Together with serious concerns about financing margin calls on their hedges, which came to a head last spring and summer, and today's worries about the availability of sufficient credit, grain elevators have not been able to offer the same broad range of cash grain marketing opportunities that producers have come to expect. The NGFA believes that the draft legislation being discussed in the Committee on Agriculture contains several provisions that will help bring added clarity and transparency to agricultural futures markets. While not a guarantee of enhanced performance, these provisions will allow all market participants a better view of the marketplace and enhanced decision-making based on who is in the market and whether activity is based primarily on investment activity or true supply/demand fundamentals. In particular, the NGFA supports the detailed reporting and data disaggregation language found in section 4 of the draft legislation. We believe identification of index traders and swaps dealers who are active in agricultural futures markets in reporting by the Commodity Futures Trading Commission (CFTC) will assist grain hedgers in making appropriate risk management decisions. The NGFA would suggest that additional legislative guidance be given to the CFTC to identify any additional market participants whose trading behavior may be similar for purposes of potentially including those participants under the same reporting requirements.Position Limit Agricultural Advisory Group Section 6 of the draft legislation would establish a Position Limit Agricultural Advisory Group. The NGFA would suggest that, at least for the grains and oilseeds contracts, the current method of determining speculative position limits is working well. Typically, if changes in position limits are contemplated, a regulated exchange would propose the new limits for a specific agricultural futures contract, often following consultation with affected market participants; the CFTC would analyze and review these levels and evaluate input from the public and relevant futures market participants during a public comment period; and the Commission then would either approve or disapprove the proposed change in position limits. From the NGFA's perspective, this process has worked well, and we believe our industry has participated in a meaningful and effective way. For grains and oilseeds, we believe the current process is preferable to a broadly drawn advisory group that may not have sufficient expertise with each individual contract (e.g., most grain industry representatives on an advisory group would have little expertise in advising on position limits for cotton).Concerns About ``Bona Fide'' Hedging Definition The NGFA's primary area of concern in the draft legislation is provisions in section 6 that would specifically define in law how the CFTC must define a ``bona fide'' hedge. We fully support the draft bill's intent: to distinguish between traditional hedgers who use futures contracts for price discovery and to hedge their price and inventory risks in cash markets, and newer, non-traditional participants who view futures markets as an investment category. For some time, the NGFA has made the case that investment capital's participation in agricultural futures markets has artificially inflated futures prices, skewed basis relationships and, especially in the case of the CBOT wheat contract, eroded the utility of futures markets for traditional participants. However, we strongly believe that legislating a concept as complex as defining a ``bona fide'' hedge--and, by extension, which entities should qualify for hedge exemptions--is fraught with risk. Even with the best of intentions, codifying this concept invokes the ``law of unintended consequences.'' We fear that a strict construction could unintentionally lay a snare for legitimate hedgers--and at the least, could have a constrictive effect on development of hedging strategies that benefit agricultural producers. We strongly urge the Committee to signal its intention to the CFTC on parameters of a ``bona fide'' hedge, but we also strongly urge that the Commission ultimately be allowed to develop and administer the definition. We would be very happy to work with the Committee to help structure such an approach.Exchange Clearing of Over-the-Counter Transactions While the NGFA does not have a formal Association position on requiring reporting or exchange-clearing of OTC transactions, we would offer a couple of observations and a caution as the legislation proceeds. We are aware that some agricultural grain buyers and processors have structured a range of OTC products that back up and complement their cash contract offerings to producers and other customers. We are not aware that these useful OTC agricultural products, which provide tailored marketing opportunities to producers and others, have experienced the same problems as credit default swaps and other financial derivatives. Futures contracts are traded and cleared very efficiently on regulated exchanges because contract terms are standardized. Due to the very nature of OTC products--which typically are customized, individually-negotiated agreements--attempting to force them through an exchange's clearing corporation could present difficulties and likely would inhibit development of new marketing tools for agricultural products. We would caution against such a result. Perhaps an approach involving reporting of OTC participants and/or transactions would be a reasonable alternative approach. We appreciate the opportunity to submit these thoughts and recommendations. The NGFA stands ready to answer any questions or provide assistance to the Committee as the legislation proceeds. Submitted Letter and Statement of Susan O. Seltzer, Former Assistant Vice President, Synthetic Securities, U.S. Bank[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Attachment 1February 2, 2009Hon. Collin C. Peterson,Chairman,Committee on Agriculture,Washington, D.C.RE: Derivatives Markets Transparency and Accountability Act of 2009 Dear Congressman Peterson: Please consider adding to the Draft Language of ``Derivatives Markets Transparency and Accountability Act'' the stipulation that it would be mandatory for all counterparties to credit default swaps to unwind these contracts, going back to January 2007. The parties to these contracts would exchange profits and losses, alleviating the U.S. taxpayer from taking on the credit default swap counterparties obligations. Shifting this burden to the U.S. taxpayer has not solved the problem and it very well may be a continuing outflow of taxpayer dollars that could be more efficiently invested to generate a higher return, say in jobs, education or infrastructure. This perspective comes from thirteen years in the over-the-counter derivative markets at a major U.S. commercial bank when the swaps markets were first developing in the early eighties. My experience included advising corporations on the use of swaps, foreign currency forwards and options for hedging transactional and translational foreign currency exposures in the inter-bank market. For the commercial bank's executive credit committee, I prepared the analysis of the counterparty credit risk in these derivative transactions, including interest rate swaps, which was always monitored on an ongoing basis. I was also involved in ensuring there were appropriate Board approved position limits on all derivative contracts used in the over-the-counter market. In addition, there is a central issue in 2009 Derivative Transparency that must be resolved prior to finalizing this bill. Please request that Treasury Secretary Geithner's office determine the ROI of using taxpayer dollars for contractual payments under credit default swap contracts. Consider having your bill reverse TARP funds and AIG loans used to date for this purpose. Insert language in the bill, which requires the unwinding of existing credit default swaps. Shift the burden of contractual payments required under credit default swaps from the U.S. taxpayer to the original parties to these contracts, effectively by unwinding these contracts. Unwinding swap contracts is unprecedented, but these times are unprecedented and AIG's right to enter into these contracts in the over-the-counter market, may have been fraudulent. Yes, all credit default swaps should be traded on a regulated exchange. However, change the language of this bill to ensure there are not any exceptions and there are not any credit defaults swaps contracts in the over-the-counter market. Finally, have the bill focus solely on credit default swaps use in the over-the-counter markets. Do not require interest rate swaps and foreign currency forwards to operate on a regulated exchange. To add to this bill the regulation of interest rate swaps and foreign currency contracts in the over-the-counter markets will add a layer of complexity and cost to commercial banks that can be deferred, until the financial crisis is resolved. As you are aware, the defenders of credit default swaps will argue, ``They help us have a gauge on corporate credit risk and sovereign risk. These active markets give us spreads that reflect market sentiment on a given credit risk. Market sentiment is not a valid indicator of true creditworthiness.'' According to the swap industry, which is promoting the ongoing use of these derivatives, they are critical to our financial markets. ``Throughout the crisis, credit default swaps have remained available and liquid,'' said Eraj Shirvani, Chairman of the International Swaps and Derivatives Association (ISDA) and head of credit sales and trading at Credit Suisse. ``They have been the only means of hedging credit exposures or expressing a view at a critical time for the industry. Impairing their use would be counterproductive to efforts to return the credit markets to a healthy, functioning state.'' There is a viable and valuable use for interest rate swaps and foreign exchange swaps and forwards in hedging interest rate and foreign currency exposures. Credit default swaps cannot effectively hedge credit risk. Credit risk, as you are aware, can only be managed by looking at the financials of the entity, at the time of credit extension and on an ongoing basis as market conditions change. Market sentiment developed through trades establishing ``an entity's credit worth'' have proven to be destructive to our financial system and their advocates have not demonstrated what value the continuing use of them will bring to our financial system. There is far greater downside, than upside, in continuing their use. One should respond to advocates of the continue use of credit default swaps with these two points: Common sense dictates a bank would not give unlimited credit or a jumbo mortgage to a borrower with an income of $50,000 and no assets. Common sense also dictates AIG should not have been allowed to enter into an unlimited amount of credit default swaps with counterparties. The AIG Board of Directors, in allowing AIG's Financial Product division to be created, did not set any parameters for AIG managing counterparty credit risk. Merrill had a $15.31 billion net loss in the 4th quarter, first reported 2 weeks ago. ``Behind some of the losses in the quarter are two related trades that Merrill hasn't disclosed publicly in detail.'' It has been reported the loss resulted from a long position in corporate bonds, ``hedged by derivatives, credit default swaps.'' When asked about this 4th quarter multi-billion loss, Mr. Thain responded, ``that was a legacy position.'' U.S. taxpayers need an answer as to why, when taxpayer funds were used by Bank of America to take over Merrill; these legacy positions were not unraveled, saving us another $15 billion that could have been put into our schools in Minnesota. How many more credit default swap ``legacy'' positions is the U.S. taxpayer going to be asking to fund? Thank you, Congressman Peterson, for taking the lead on unraveling the quagmire created by credit default swaps to swiftly restore our banking system to a functioning level. Again, I would recommend Washington listen to a more diverse opinion on credit default swaps. Reforms in this derivative have the appearance of being led by an Executive Branch that comprises many former bankers and economists with a vested interest in continuing to maintain credit default swap profits, while placing the burden of the losses on the taxpayers. As an unemployed Minnesotan, I would be pleased to come to Washington to work to research other viable alternatives to ensure taxpayer dollars are invested in a prudent fashion, as we work to unwind the aftermath of irresponsible, if not fraudulent, credit default swap financial contracts. Sincerely,Susan O. Seltzer,Former Assistant Vice President, Synthetic Securities,U.S. Bank. Attachment 2MinnPost.comhttp://www.minnpost.com/community--voices/2009/02/04/6377/join_rep_peterson_in_solving_the_credit-default-swaps_messJoin Rep. Peterson in solving the credit-default-swaps messBy Susan Seltzer,Wednesday, Feb. 4, 2009 Minnesotans have an opportunity to take an active role in partnering with Rep. Collin Peterson, D-Minn., to ``effectively'' ban the further use of credit default swaps. Nouriel Roubini, professor of economics and international business at New York University's Stern School of Business, has cited credit default swaps as a pivotal factor in the collapse of our financial system. House Speaker Nancy Pelosi has appointed Peterson as her leader to get the derivative mess under control. Last November, he traveled to Europe to meet with international banks to get perspective on how to unwind the credit-default-swap derivative mess, which today still weighs heavily on the ability to restore our financial system. Peterson, who chairs the House Agricultural Committee, has an accounting background and a strong understanding of exchange-traded derivatives, through his committee's work with the Commodity Futures Trading Commission (CFTC). Draft language for a bill, ''Derivatives Markets Transparency and Accountability Act of 2009,'' was posted on the Agriculture Committee's website last week and is being debated in Congress today. One part of this bill serves to place all credit default swaps, interest-rate swaps and foreign-currency forwards currently being traded in the inter-bank or over-the-counter market on a regulated exchange. Certain ``customized'' credit default swaps may be exempt. The bill proposes that credit default swaps only be used to hedge an underlying bond or position.Lobbyists are already pushing back Peterson's proposed bill is already getting strong pushback from lobbyists, including the International Swap Dealer's Association (ISDA) and major banks. The Treasury secretary's nominated chief of staff, Tom Patterson, was a lobbyist for Goldman Sachs until last year. Revenue from financial services firms was over 25 percent of our GDP last year, a significant portion from credit default swaps. There is a strong incentive to maintain this revenue stream, but is this a revenue stream we want? Taxpayers do not yet have advocates that serve to protect our new ownership interest in AIG and other financial institutions. It may make sense to ask Peterson to consider adding to his bill the stipulation that it would be mandatory for all counterparties to credit default swaps to unwind these contracts, going back to January 2007. The parties to these contracts would exchange profits and losses, alleviating the U.S. taxpayer from taking on the credit default swap counterparties' obligations. Shifting this burden to the U.S. taxpayer has not solved the problem, and it very well may be a continuing outflow of taxpayer dollars that could be more efficiently invested to generate a higher return, say in jobs, education or infrastructure. This perspective comes from 13 years in the over-the-counter derivative markets at a major U.S. commercial bank when the swaps markets were first developing in the early 1980s. My experience included advising corporate CFOs on the use of swaps, foreign-currency forwards and over-the-counter options for hedging transactional and translational foreign currency exposures. For the commercial bank's executive credit committee, I prepared the analysis of the counterparty credit risk in these derivative transactions.Seen in '90s as a win-win It was not until the late 1990s that a J.P.Morgan trader worked to solve the ongoing issue of managing ``credit risk'' and created the derivative, a credit default swap. The rest is history. There were some vocal skeptics, including Brooksley Born, former chair of the CFTC. Senate Banking Committee testimony in 2005 concluded that the use of credit default swaps was a win-win for all parties and there was no reason not to allow their ongoing use in the over-the-counter markets. Counterparty credit risk was not managed with credit default swaps, since inception. Players in these over-the-counter markets--like hedge funds, AIG and investment banks--have typically had a different credit-risk orientation from commercial banks. Derivatives, used in the correct context, are powerful tools to hedge interest-rate risk and foreign-currency exposures. Derivatives have been a source of stability and revenue for major banks in both the over-the-counter market and regulated exchanges, and should continue to be. They are used by banks to manage mismatches in loan positions, to hedge risk of floating rate debt, for example. Small Minnesota importers use them, through commercial banks, when they buy products in foreign currency, to hedge their foreign-currency exposure. Hedging with derivatives is a more conservative position than not hedging.Mostly used for speculation In contrast, credit default swaps were used for speculation in the majority of cases. Unlike interest-rate swaps and foreign-exchange forwards, they do not provide any underlying value to the U.S. banking system. (For some recent background on the credit default swap market, here is a link to a blog, Naked Capitalism (http://www.nakedcapitalism.com/2007/08/are-credit-default-swaps-next.html), from August 2007, which details concerns on the credit default swap house of cards. In addition, a May 2008 Bloomberg story provides good history of how the Federal Reserve appointed J.P.Morgan to oversee the black hole of the CDS market with their takeover of Bear Stearns.) So what is the next step regarding Peterson's draft bill on transparency and regulation in the derivative markets? First, ask Treasury Secretary Timothy Geithner's office to determine the efficiency of using taxpayer dollars for contractual payments in credit default swap contracts. Consider having Peterson's bill reverse TARP funds and AIG loans used to date for this purpose. Insert language in the bill that requires the unwinding of existing credit default swaps. Shift the burden of contractual payments required under credit default swaps from the U.S. taxpayer to the original parties to these contracts, effectively by unwinding these contracts. Second, implement Peterson's recommendations that all credit default swaps must hedge an underlying position. Yes, all credit default swaps should be traded on a regulated exchange; however, change the language of this bill to ensure there are not any exceptions. Third, and finally, have the bill focus solely on credit default swaps' use in the over-the-counter markets. Do not require interest-rate swaps and foreign-currency forwards to operate on a regulated exchange. To add to this bill the transfer of interest-rate swaps and foreign-currency contracts in the over-the-counter markets to a regulated exchange would add a layer of complexity and cost to commercial banks that can be deferred until the financial crisis is resolved. Do require disclosure and reporting requirements, as stipulated in the proposed bill, on interest-rate swaps and foreign-currency-forward contracts. Congratulations to Rep. Collin Peterson for taking the lead in unraveling the quagmire created by credit default swaps. Susan Seltzer is a former Assistant Vice President, Synthetic Securities of U.S. Bank. ______ Submitted Statement of A. James Jacoby, President, Standard Credit Securities, Inc. Chairman Peterson, Ranking Member Lucas, and Members of the Committee: Good morning. My name James Jacoby. I am President of Standard Credit Securities, Inc., a registered broker/dealer and leading provider of execution and analytical services to the global over-the-counter inter-dealer market for credit cash and derivative products. I have been an active participant in both the OTC and on exchange securities markets since 1959 and have witnessed both the successes and challenges in the CDS market. I would like to thank this Committee for the opportunity to share my thoughts on the draft legislation on Derivatives Markets Transparency and Accountability Act 2009, as it applies to the over-the-counter market generally and the credit derivatives market specifically. The Committee's draft legislation comes at a significant time. In my view, any legislation that attempts to address derivative market accountability and transparency should reflect an historical perspective on the law of unintended consequences as it may arise from such legislation. With this in mind, I would like to briefly comment on two areas of the draft legislation that bear special attention: Underlying Bond Ownership Requirements of CDS. Unintended Consequences of Inappropriate Regulatory Action.Bond Ownership as Prerequisite for CDS Transactions Section 16(a)(h) proposes to make it ``unlawful for any person to enter into a credit default swap unless the person would experience financial loss if an event that is the subject of the credit default swap occurs.'' Such a prohibition would effectively eliminate the credit default swap business in the United States. This provision would strip liquidity from the market and it would cease to function as an effective risk transfer arena. To limit the participants to those who ``would experience financial loss'' narrows the market to very few participants and eliminates the many sources of liquidity. Essentially, a bond owner who seeks a CDS as a hedge against the potential default, will lack the ability to enter into such a transaction. No one will have the same risk of default that that is being hedged and, at the same time, be willing to enter into a swap. It seems that the only person from whom a swap could be purchased would also have to have exposure to the same default. Would not that person be seeking the same protection? If, for instance, only farmers could trade in the grain markets because of their potential loss, the market would be very thin, spreads very wide and volatility extreme. Speculation, under such circumstances, is not a bad characteristic and provides much needed liquidity in the market place. The same must be said for the CDS market.Unintended Consequences of Legislation Comparisons have been offered between the effect the proposed legislation would have on the credit intermediation and risk transfer functions of the market and the effect the Trade Reporting and Compliance Engine (TRACE) regulation had on the secondary high yield bond market. These comparisons, I believe, are very instructive. When Congress mandated more transparency in the securities market it is unlikely that the impairment of the secondary high yield bond market was intended. However, that unintended consequence occurred and effectively ended the secondary high yield bond market as a viable market in which dealers, institutions and investors could participate. The deterioration of the secondary high yield bond market came about not a result of a ``slowdown'' in underwriting or other business cycle ripple effect, but as a result of new regulations that created the trade reporting mechanism. How did this happen? The process for increased transparency in the secondary high yield bond market was the subject of great debate over a period of years. I was Chairman of the NASD's Bond Transparency Reporting Committee and this committee urged the NASD to rethink the extent to which such regulation would impact market viability. We offered detailed explanations as to why the transparency being mandated would lead to the impairment of that market. Our advice notwithstanding, the NASD adhered to the mandate for increased transparency and produced transparency in intimate detail. Further, the NASD then insisted that the detail of each trade, regardless of size, be published in such a short period of time after a trade was executed that the financial incentive for dealers and underwriters to participate was eliminated and the market dried up. Underwriters and dealers were no longer able to price in their capital risk, profit objectives and costs into these transactions and thus they dramatically reduced their participation in the secondary high yield bond market. The secondary high yield bond market has yet to recover. Most of the offerings which were the subject of the secondary high yield bond market related to non-investment grade bonds. By all accounts this market was at least 50% of the total corporate bond market prior to TRACE. Investment grade offerings can be, and are, hedged in the government market because of their correlation. In the secondary high yield market, dealers cannot effectively hedge using government securities because the correlation between the two is too low. Since TRACE effectively eliminated the market making function traditionally performed by dealers, they were loath to undertake original issues of such non-investment grade offerings, because there would be limited distribution into the secondary market after the first trade was done and the street had access to the intimate details of the trade. Once the price was published on the first trade no one would lift an offer at a higher rate. Subsequently, the market has deteriorated. Interestingly enough, the growth in the credit default market correlates to the deterioration of the secondary high yield bond market. Once the full effect of TRACE became apparent, in order for the dealers to try to maintain a dealer market, dealers looked to the CDS market as a hedge against their ability taking potions in the secondary cash high yield market. London has a very active and competitive CDS market and they would welcome regulation that would further inhibit the viability of the U.S. CDS market. Such regulation would facilitate the movement of this transportable market to any number of overseas markets, such as London, Hong Kong, Tokyo, Dubai, and others. I offer these observations for an historical perspective on the law of intended consequences. I urge the Committee to examine in detail the effect that the proposed legislation will have on the CDS market and to reflect on the number of U.S. companies raising capital outside the United States in order to avoid the consequences of TRACE. Likewise, an increasing number of non U.S. companies have elected to delist from the U.S. equity markets because of the impact of Sarbanes-Oxley. London has taken the global leadership position as a venue for issuance of new equity and debt underwritings. By all accounts London will continue to occupy this global leadership position as more and more foreign corporation delist from the U.S. equity markets. In closing, I urge the Committee to carefully consider the potential impact of the proposed regulation on the continued viability of the United States as a leader in the global capital markets. Submitted Letter of Steve McDermott, COO, ICAP[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Attachment 1 submitted statement of christopher ferreri, managing director, hybrid trading, icapProposed Derivatives Markets Transparency and Accountability Act of 2009ICAP Comments as at 10 February 2009 ICAP would like to comment on a few specific aspects of the draft legislation entitled the Derivatives Markets Transparency and Accountability Act of 2009, which was recently distributed by the House Agriculture Committee and the subject of 2 days of hearings by the Committee on February 3rd and 4th.About ICAP--Leading Broker in the OTC Markets ICAP is a publicly held company traded on the London Stock Exchange (symbol ``IAP''), has 4300 employees and maintains a strong presence in the three major financial markets--New York, London and Tokyo, together with a local presence in 30 other financial centers around the world. ICAP covers a broad range of ``over the counter'' (OTC) products and services in commodities, foreign exchange, interest rates, credit and equity markets as well as data commentary and indices. While ICAP does broker credit default swaps (CDS), it is a relatively small part of our overall OTC and exchange related business that intermediates $1.5 trillion in transactions between its clients each day. ICAP is an Inter Dealer Broker whose sole objective is to bring together willing buyers and sellers to complete transactions and is the leading global broker in wholesale financial market. It sits at the crossroads of wholesale financial markets, facilitating the flow of liquidity in both the OTC and exchange transactions between commercial and investment banks and dealers representing companies, governments or other major financial customers around the world. ICAP also owns and operates a number of OTC trading platforms and post trade services and has a strong interest in the continuing health, efficiency and safe operation of the global wholesale financial markets.Specific Comments on the Draft Legislation ICAP wants to address two major aspects of the bill. We agree with the thrust of section 13 of the bill to require central clearing for credit default swaps in lieu of mandating that these instruments be traded exclusively through an exchange. It is vitally important to understand the differences between central clearing and mandated exchange trading. The Committee has heard testimony on the benefits and limitations of exchange-traded products and over the counter trading. It is our viewpoint that the two can, and do, successfully coexist. In fact, there are numerous examples in the OTC markets where centrally cleared trading is the standard by which other markets can be judged. The most liquid, actively traded securities globally, U.S. Treasury Bills, Notes and Bonds, trade just this way. There is substantive evidence of OTC markets that operate together with exchange-traded, complimentary products. References to transaction frequency and customized products in section 13 are vague and subjective and we would welcome the opportunity to help craft appropriate guidelines. It the cases where a standardized futures contract can be designed to help hedge against the default of a borrower, those standardized contracts may attract sufficient liquidity to generate active open interest. In the event a more customized contract is necessary, the proposed exemptions should apply. There are examples in the markets where exchange-traded contracts and the underlying security co-exist and increase the overall liquidity of both products. In these markets, ICAP currently captures all transactions electronically and employs technology to automate trade reporting, affirmation and confirmation. It is important to note that market participants retain the ability to trade via multiple execution venues, encouraging competition and reducing costs, still, with access the same clearing pool. It would be very destructive to market efficiency and open competition to mandate a single place to trade assets, or to create a monopoly in trade execution and clearing. ICAP respectfully submits reservations with the broad scope of section 16 and the limited space dedicated to this issue. To limit the access to this marketplace only to those who have a direct ownership of the underlying obligor by its very nature will eliminate the sellers in the marketplace as they are writing the protection to those holding the underlying. This limitation will essentially eliminate credit default swaps. The credit default swap market serves as the only market-based method of price discovery and liquidity for establishing a market value of a company's credit. This is the only place that market participants can place a value on a company's ability to service or repay a loan. Much has been written about the possible negative impact of a credit default swap; however the alternative is more opaque and subjective. We have seen the ratings agencies fail in their ability to properly predict and forecast the deterioration of the credit rating of a company and the procedures with which those agencies operate has been in question. The credit default market actually increases the transparency of the credit worthiness of an obligor and generates a market value for that credit ranking. ICAP agrees with the Committee in the concept of clearing to increase transparency in financial reporting. The benefits of increased market transparency, automated post trade processes and availability of real-time market data will create the lion's share of the benefits to the credit default swap market and that limiting access to an exchange will essentially limit the benefits of the improvements. Fairness, transparency and suitable regulatory restraints will foster an environment that will help market participants better manage their risks and exposures.The Context and Utility of OTC Markets As an integral part of the OTC markets and the leading global Inter Dealer Broker, we felt it was important to comment at this early stage in the process to highlight the importance of the derivatives markets and the central role they play in risk management and economic growth. ICAP has significant expertise in the OTC markets and has deployed electronic trading systems for a number of products, including credit default swaps. Approximately 60% of our CDS trading in Europe is electronically traded with all live, executable prices posted on these systems. In the U.S., the sovereign CDS market trades in a hybrid voice/electronic model with all live executable prices posted for all market participants to see. The structure of the markets and the ways in which the Inter Dealer Broker operates help increase and simplify price discovery, trade execution, trade reporting and post trade processing. Our ability to respond quickly to the changing needs of a marketplace has been a trademark of our company. The OTC environment is already full of examples where execution is on ``exchange-like'' systems and which are already centrally cleared, with the attendant advantages of transparency and auditability. Not all parts of the OTC space can survive without IDB intermediation, nor can market participants take on the risk of buying and selling in extreme market conditions without having an anonymous means of ``sounding out'' the market. Even then, ICAP has been a long-time advocate of clearing and the utilization of a Central Counter Party model, more rapid trade confirmation and reconciliation, the elimination of reset risk, and portfolio compression (of which more consideration is given below). ICAP's businesses submit very large volumes of OTC transactions to DTCC (FICC, MBSCC and other related systems) and LCH.Clearnet on behalf of its customers on a daily basis. It's critical that we avoid further constraining the flow of capital at a time when we should be encouraging its efficiency--particularly given the turmoil in the economy. Certain key assets, such as public debt, only trade in the OTC environment and such markets of course play a critical role in facilitating capital raising and providing financing that enable companies to operate, expand and provide employment for millions of Americans. The OTC markets have developed in parallel to those markets traded on traditional stock, futures or commodities exchanges and the relationship between the traditional exchanges and the OTC market is more symbiotic than competitive. ICAP owns and operates a number of OTC trading platforms and integrated post trade services and understands this relationship. OTC and exchange markets each have separate, distinctive and logical reasons to exist--none of which are called into question by the recent market turmoil. Exchanges such as NYSE, NASDAQ, the London Stock Exchange and the CME Group--provide a trading platform for assets that are by their nature simple, in as much as they are all based on a single key measure (such as the anticipated financial performance of a company in the case of shares of stock or the value of a commodity at a time in the future in the case of exchange listed derivatives). In contrast, the wholesale OTC markets offer a deep and liquid trading environment for professional market participants such as major banks, insurance companies and other financial institutions, to execute transactions, the key terms of which are individually negotiated, rather than standardized. The OTC market has continually evolved over the last 25 years alongside the exchanges and serves a vital role in creating transparent credit and capital markets. Standard exchange-traded contracts very rarely provide a perfect hedge for actual economic risk and in fact can result in hundreds of variances to the original protection risk and increasing the frequency of trades. By contrast, users of the OTC markets can use non standardized financial products like credit default swaps or interest rate swaps to hedge their risk more precisely and transfer part of that risk to other professional OTC market participants. Consider the following example of standard contracts used to manage risk. A contractor is bidding on the plumbing system in the Freedom Tower, a project that will last for nearly a decade. The contractor is required to quote a complete price for the project, and has to take into consideration what materials and labor will costs several years out. After a thorough review of the plans, and using his expertise, he determines that he will need the equivalent of 100,000 pounds of copper for the job. Clearly, if the price of copper should increase, he may not be able to meet his obligation. The simple financial hedge is to buy copper futures and include the cost of the futures in his estimate. So the contractor enters an order to hedge the cost of 100,000 pounds of copper to a specific date in the future and he's good to go--not quite. You see, the hedge was simply a financial hedge to lock in a specific prices of underlying metal at a specific point in time; but you can't use just the metal for plumbing. You need fittings, elbows, tees, drains, valves and all of the other specialized components of a plumbing system. The contractor doesn't have a complete hedge against an increase in manufacturing costs of these goods, a specific date when the goods will absolutely be needed, protection against a fall in the value of the U.S. dollar that would impact the costs of imported fittings, a hedge against an increase in shipping or trucking costs and so on. A prudent contractor might seek to have interest rate and potentially currency exchange rate protection over the life of the contract; this level of financial expertise would not typically be found in a plumbing company. Without the efficient operation of the wholesale segment of the market the cost of providing interest and/or currency rate insulation for the contractor would be substantially more difficult and expensive.An Opportunity to Improve Regulation While OTC markets have played a major role in global economic development and have been the hub of developments that benefit savers, investors, businesses and governments, we think their operation and effectiveness can be improved and ICAP favors changes to the regulatory framework supporting these wholesale financial markets. The challenge, of course, is for the regulation to be effective and limit any unintended consequences on the governmental entities, corporate and retail borrowers and investors that now rely on these markets. Specifically, the regulatory response to current events needs to focus on expanding and enhancing the transparency of the already existing OTC market infrastructure and making it more robust in those areas where it is too fragile. Regulations should mandate--as the New York Federal Reserve and others have been proposing--wider adoption of central counterparty (CCP) give up and or central clearing for OTC derivative markets. A Central Counter Party together with central clearing that is independent of the trading platforms and does not limit available sources of liquidity for those markets should be mandated for all markets. The solution to current problems in financial markets also does not lie in attempting to mandate the transfer of OTC trading onto existing exchanges. OTC markets have traded, and need to continue to trade, separately from exchange markets for many reasons. OTC markets are both larger in scale and broader in scope than exchange markets and provide a vital risk management tool. An exchange solution also needlessly grants the exchange a monopoly on trade execution to a single vertical of trading, clearing and settlement, which limits competition and is usually accompanied by restricted access to clearing--which will lead to increased costs, increased risk and less flexibility for market participants. The OTC market has already invested significantly in developing its infrastructure for price discovery, trade execution and post trade automated processing which contributes hugely to reducing risk. but it needs to be further developed and better leveraged for the benefit of all. ICAP has been an industry leader in developing solutions to reduce systemic and operational risk in the OTC markets, including the portfolio reconciliation and compression areas. TriOptima, a private company in which ICAP holds a minority interest, operates a global reconciliation and compression platform that has been in use for nearly a decade. Only through the prism of experience in servicing our markets can a clear vision of future improvements be seen. We have a history of innovation in an industry of innovation and would welcome the opportunity to broaden the knowledge of those charged with building a more robust regulatory environment.Summary and Additional Reference Material ICAP would like to thank the Committee again for this opportunity to comment on the proposed legislation to regulate certain aspects of the over the counter market. In addition to this statement, we would ask that a White Paper entitled, The Future of the OTC Markets, by Mark Yallop, Group Chief Operating Officer, ICAP, dated November 10, 2008 also be included in the hearing record. The paper goes into detail as to ICAP's positions on strengthening the OTC markets, but the key points that we believe can improve the way the OTC markets operate include a wider adoption of electronic trading; quicker settlement cycles; faster and automated trade confirmations; and greater use of netting and portfolio reconciliation and compression. Thank you and we look forward to working with the Committee as this legislation moves through the House and hope you will use ICAP as a resource given our experience and the scope of our operations. Attachment 2[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] " CHRG-111shrg57320--361 Mr. Corston," A C negative would clearly indicate that it would be heading towards a 3. As a C stable, it would certainly have the risk characteristics of an institution that could be heading to a 3 if it was under some level of stress. You can see the areas where it was most vulnerable, most notably in the area of credit risk, which was increasing in nature. That is probably the first red flag in this report. Senator Levin. And what is the date of this? " FOMC20070807meeting--152 150,CHAIRMAN BERNANKE.," Well, right. You really have to rewrite the sentence. Let me try to evaluate this with your guidance. [Laughter] So I agree with Brian that this is one of the toughest ones to write and to assess the response. If you read the commentary, expectations are all over the map, and so it is very difficult to know how this will be taken. I don’t pretend to know. Let me start with something easy. I think that President Plosser is absolutely right. There is no reason to change paragraph 3 without a reason. So unless anyone has concerns, I’d like to change paragraph 3 back to the June language. Okay. That’s the first thing. Regarding the tougher question—and President Yellen, President Poole, and others have raised an interesting possibility—again, without much confidence I am going to resist it for the following reasons. The first reason is mostly that it is complicated, [laughter] and it moves things around in ways that will make it even harder for the market to understand what we’re trying to do. Another reason is that the statement “although the downside risks to growth have increased somewhat,” if we follow your advice and put it after the new sentence in paragraph 2, will essentially say that the financial markets are the reason that the downside risks have increased, whereas there are other factors—the housing market, automobile sales, and things of that sort—that could be viewed as increasing the downside risks. So I guess that’s my recommendation. On “predominant,” I think the word has been neutralized to a significant extent by its use. You may recall that we used the phrase “predominant policy concern,” and we changed the second sentence, and the market based on that decided that we had gone all the way to balance. My concern is that, if we get rid of “predominant” and if we mention the downside risks to growth anywhere, that will be viewed as having gone mostly to balance, and I don’t think that’s where we are right now as a Committee. I have one thought, which may have come too late in the day here. This is going back to paragraph 2, “financial markets have been volatile in recent weeks.” President Geithner raised the idea of changing that to something about risk. One small concern I have, and it would have been good had we put this in earlier, is that the phrase refers to something going on in the markets per se and not an effect of the markets on the economy, which heightens some of the put risk a little. An alternative would be to replace that first phrase with something like “investors have demanded greater compensation for risk.” That would be a market development that evidently affects yields and borrowing costs. I see some nodding. I see some frowning. So I’m not sure." FOMC20070628meeting--132 130,MR. KOHN.," Thank you, Mr. Chairman. My projection was closely in line with that of the Greenbook, modestly below-trend growth for a few quarters, held down by a prolonged weakness in housing. As that drag abates, the economy picks up to potential and is held back from overshooting that potential by various factors, including the rise in the saving rate and slightly lower growth of government spending. Under these circumstances, core PCE inflation holds in the neighborhood of 2 percent. I do not really see much to push it one way or another at this point. The economy is producing very near its potential, as close as we can figure. Inflation expectations have been moving in a narrow range. Some of the transitory factors, such as owners’ equivalent rent, that we’re expecting to come down to reduce inflation have already done that to a considerable extent. So I don’t see them, moving forward, as having a big effect. Given the limited pass-through of energy and commodity prices into core prices, I would not expect much downward pressure on inflation from a leveling-out of those prices. I think that we are around 2 percent and that we will probably stay there, at least for a little while. In terms of risks, the recent data on capital goods, orders and shipments, and manufacturing activity suggest, as many have remarked, some reduced downside risk from business attitudes on spending. They do not suggest a great deal of strength in business capital spending, however. The fundamentals are less favorable than they were a couple of years ago, and the most recent data, which we received today, suggest a pretty flat or a modest upward tilt to capital spending in the second quarter. The data weren’t that strong, but they do suggest that what I feared in May—that we were in the midst of a cyclical adjustment that was going to make capital spending much weaker—has certainly abated. I agree with many others around the table that housing is a significant downside risk to the forecast, given the high level of inventories despite a major reduction in starts over the past year and the price-to-rent ratio being as high as it is. The further slide in housing may be gentle, as President Lacker said, but I do not think we’ve seen the bottom yet. You can go a long way at a gentle slope. [Laughter] We also have not yet really seen the full effects of the tightening in subprime credit terms or, obviously, of the recent increase in mortgage rates. I also see a big downside risk from consumption. The Greenbook has the growth of consumption sustained despite an increase in saving rates as the growth in disposable income exceeds the growth in GDP—and that is with the labor share recovering and the business profit share declining. I see two downside risks to that. One is that the saving rate will rise faster as the housing weakness feeds through both in terms of wealth effects and in terms of reduced availability of credit as terms tighten and there is less equity to borrow against, particularly for liquidity-constrained households. I also continue to see a downside risk to equity prices, although I have certainly been wrong so far. Nellie’s table presenting the difference between the staff’s forecast of profits and the market’s forecast of profits showed a huge difference for next year. So though I think the basic outlook is fine, I still see some downside risk on that side. On the inflation front, I, like others, see the better-than-expected core inflation as a hopeful sign; but it is recent and may be affected by temporary factors, and I do not think we need to get too enthusiastic about it. I do see several upside risks to inflation: the high level of total headline inflation, which could erode inflation expectations; business resistance to any erosion of profit margins as unit labor costs pick up; the high levels of resource utilization in the United States; and the tighter global conditions of demand on potential supply that others of you have mentioned. Let me say a word or two about my year-three projections. I projected output growth at 2½ percent, the unemployment rate at 4¾ percent, and core PCE inflation at 1.9 percent. I certainly saw my output and employment projections as a sense of what the steady state was. On the unemployment rate, I do think the odds are better that the NAIRU is lower than that it is higher than the staff’s 5 percent assumption. This judgment is partly based on the very moderate pickup in the employment cost index, and average hourly earnings growth has actually been coming off recently. On the behavior of core inflation, I don’t see much evidence that we are significantly beyond potential now, although I recognize that, with a very flat Phillips curve, it could be a long time before one figures that out. But I had growth of potential at 2½ percent, which is below what I infer to be the central tendency of the Committee. Regarding my reading of the decline in productivity growth, productivity over the past five quarters has been growing significantly below the staff’s estimate of 2½ percent. Some of it is cyclical. There could be a revision, as Presidents Plosser and Yellen have suggested. I confess to having asked David Wilcox about this at the break, and he said that the data are kind of ambiguous here and that it is much too early to predict a significant downward revision to employment. But I hope you are right. Now, some of the recent slowdown certainly must be cyclical, though I would have thought that labor hoarding and things like that would be much less in today’s flexible labor markets, with so much more use of temporary workers than there has been in the past. I would think that the cyclical effects on productivity would be muted, that businesses would move pretty promptly to adjust their labor forces to output. So I wonder how much cyclicality there is. The big uncertainty is in the construction industry and in the fact that construction employment hasn’t come down. We don’t quite understand why it hasn’t come down more. So perhaps productivity will pick up. But I still would look at the staff’s 2½ percent as having even just a little more downside than upside risk to it, given the fact that we have had more like 1 to 1½ percent in the past four or five quarters. So I stuck with the staff’s forecast of 2½ percent potential GDP. In some sense, our view of what the potential growth rate is isn’t all that important for monetary policy. We ought to be looking at the gap. We ought to be looking at the pressure of the level of production on the level of potential GDP. But I don’t think it’s quite that easy. We don’t know what that gap is. We have seen that the surprises over the past year or two have been in the behavior of the unemployment rate and capacity utilization relative to growth. So we do tend to look at our estimates of potential growth and the actuals coming in relative to those estimates and pass judgment on what’s happening to the output gap even when the unemployment rate doesn’t move. We just need to remember that potential growth is an entirely estimated number that we will never observe, and we need to be aware that it might not be quite as high as the central tendency indicates that my colleagues on the Committee apparently think it is. Thank you, Mr. Chairman." FOMC20070131meeting--104 102,MR. MOSKOW.," Thank you, Mr. Chairman. I just want to follow up on Vice Chairman Geithner’s first question—on inflation. It seems to me that most of the factors that are leading to lower inflation in this forecast period are temporary—energy prices, owners’ equivalent rent, and import prices. The longer-term factors are the pressures in the labor market that we’ve talked about and maybe some follow-through from the earlier accommodative financial conditions that we’ve had. As you said, chart 6 of the Bluebook, when you look past the forecast period, doesn’t show inflation coming down. Inflation actually goes up a bit with both the 1½ percent target and the 2 percent target. Doesn’t this mean that expectations have moved up a bit when you see inflation go up in ’09 and beyond?" CHRG-111shrg50564--2 Chairman Dodd," The Committee will come to order. Let me thank all of my colleagues, and I think you all understood we intended, obviously, at some time earlier to have this hearing a little earlier. But as I think all of you may know, we had an interesting session on our side of the aisle, gathering today to listen to some of our new economic team under President Obama, as well as the President himself and others, talk about many of the issues that are confronting the country, not the least of which was the issue of the subject matter of this hearing, the modernization of the U.S. financial regulatory system. I am particularly honored and delighted to have Paul Volcker here with us, who has been a friend for many years, someone I have admired immensely for his contribution to our country. How we will proceed is, because we are getting underway much later than normal for the conducting of Senate hearings, with the indulgence of my colleagues, I will make some opening comments myself, turn to Senator Shelby, and then we will go right to you, if we could, Chairman Volcker. Then I will invite my colleagues and tell them that any opening comments that they do not make for themselves, we will include them in the record as if given. And since there are not many of us here, we can move along pretty quickly, I hope, as well. So, with that understanding, we will get underway and, again, I thank all of you for joining us here today. Today, we continue the Senate Banking Committee's examination of how to modernize our outdated financial regulatory system. We undertake this examination in the midst of a deepening recession and the worst financial crisis since the Great Depression in the 20th century. We must chart a course forward to restore confidence in our Nation's financial system upon which our economy relies. Our mission is to craft a framework for 21st century financial regulation, informed by the lessons we have learned from the current crisis and designed to prevent the excesses that have wreaked havoc with homeowners and consumers, felled financial giants, and plunged our economy into a recession. This will not be easy, as we all know. We must act deliberately and thoughtfully to get it right. We may have to act in phases given the current crisis. But inaction is not an option at all, and time is not neutral. We must move forcefully and aggressively to protect consumers, investors, and others within a revamped regulatory system. Last Congress, this Banking Committee built a solid foundation upon which we will base our work today, and I want to once again thank Dick Shelby, former Chairman of this Committee, and my colleagues, both Democrats and Republicans, who played a very, very constructive role in the conduct of this Committee that allowed us to proceed as we did. Subcommittees and Committees held 30 hearings to identify the causes and consequences of this crisis, from predatory lending and foreclosures, to the collapse of Bear Stearns, the role of the credit rating agencies, the risks of derivatives, the regulation of investment banks and the insurance industry, and the role and condition of banks and thrifts. The lessons we have learned thus far have been rather clear, and let me share some of them with you. Lesson number one: consumer protection matters. The current crisis started with brokers and lenders making subprime and exotic loans to borrowers unable to meet their terms. As a former bank regulator recently remarked to me, ``Quite simply, consumers were cheated.'' Some lenders were so quick to make a buck and so certain they could pass the risk on to the next guy, they ignored all standards of prudent underwriting. The consumer was the canary in the coal mine, but no one seemed to notice. Lesson number two: regulation is fundamental. Many of the predatory lenders were not regulated. No one was charged with minding the store. But soon the actions of these unregulated companies infected regulated institutions. Banks and their affiliates purchased loans made by mortgage brokers or the securities or derivatives backed by these loans, relying on credit ratings that turned out to be wildly optimistic. So we find that far from being the enemy of well-functioning markets, reasonable regulation is fundamental to sound and efficient markets, and necessary to restore the shaken confidence in our system at home and around the globe. Lesson number three: regulators must be focused, aggressive, and energetic cops on the beat. Although banks and thrifts made fewer subprime and exotic loans than their unregulated competitors, they did so with impunity. Their regulators were so focused on banks' profitability, they failed to recognize that loans so clearly unsafe for consumers were also a threat to the banks' bottom line. If any single regulator recognized the abusiveness of these loans, no one was willing to stand up and say so. And with the Fed choosing not to use its authority to ban abusive home mortgages, which some of us have been calling for, for years, the regulators were asleep at the switch. Lesson number four: risks must be understood in order to be managed. Complex instruments, collateralized debt obligations, credit default swaps designed to manage the risks of the fault loans that backed them turned out to magnify that risk. The proliferation of these products spread the risk of subprime and Alt-A loans like an aggressive cancer through the financial system. Institutions and regulators alike failed to appreciate the hidden threat of these opaque instruments, and the current system of regulators acting in discrete silos did not equip any single regulator with the tools to identify or address enterprise or systemwide risks. On top of that, CEOs had little incentive to ferret out risks to the long-term health of their companies because too often they were compensated for short-term profits. I believe these lessons should form the foundation of our effort to shape a new, modernized, and, above all, transparent structure that recognizes consumer protection and the health of our financial system are inextricably linked. And so in our hearing today and those to come--and there will be many--I will be looking for answers to these questions. What structure best protects the consumer? What additional regulations are needed to protect consumers from abusive practices? We will explore whether to enhance the consumer protection mission of the prudential regulators or create a regulator whose sole job is protecting the American consumer. How do we identify and supervise the institutions and products on which the health of our financial system depends? Financial products must be more transparent for consumers and institutional investors alike. But heightened supervision must not stifle innovation of financial actors and markets. Third, how do we ensure that financial institution regulators are independent and effective? We cannot afford a system where regulators withhold bold and necessary action for fear that institutions will switch charters to avoid stricter supervision. We should consider whether a single prudential regulator is preferable to the alphabet soup of regulators that we have today. Fourth, how should we regulate companies that pose a risk to our system as a whole? Here we must consider whether to empower a single agency to be the systemic risk regulator. If that agency is the Federal Reserve Board, we must be mindful of ensuring the independence and integrity of the Fed's monetary policy function. Some have expressed a concern--which I share, by the way--about overextending the Fed when they have not properly managed their existing authority, particularly in the area of protecting consumers. Fifth, how should we ensure that corporate governance fosters more responsible risk taking by employees? We will seek to ensure that executives' incentives are better aligned with the long-term health of their companies, not simply short-term profits. Of course, my colleagues and our witnesses today may suggest other areas. I do not mean to suggest this is the beginning and end-all of the questions that need to be asked, and I welcome today's witnesses' as well as our colleagues' contributions to this discussion and the questions that ought to be addressed. I look forward to moving forward collaboratively in this historic endeavor to create an enduring regulatory framework that builds on the lessons of the past, restores confidence in our financial system, and recognizes that our markets and our economy will only be as strong as those who regulate them and the laws by which they abide. That is the responsibility of this Committee. It is the Republican of this Congress. It is the responsibility of the administration. I will recognize Senator Shelby for an opening comment and ask my colleagues if they might withhold statements, at least at the outset, so we can get to our witnesses. With that, I turn to Senator Shelby. CHRG-111shrg50815--49 Mr. Clayton," Sure. Credit card issuers are subject to the same economic influences that are out there affecting everyday consumers and every other lender in the country. Card companies are under particular stress right now. A number of them are losing money and have indicated in recent reports significant losses on their card portfolios, which actually reflects the underlying risk of this product. I mean, people talk about how much consumers are getting in debt or can't pay it back. Well, lenders who make loans to those people are the ones at risk here of not getting paid. So there is a significant amount of stress right now. Senator Corker. Mr. Chairman, I have got two daughters that are in college and every time we have a hearing or some discussion about credit cards, I literally call them that day--the credit card industry won't like this--to make sure they do not have a credit card, OK, that they have only a debit card or a check card. So I actually appreciate many of the fears that people and many of the concerns that people have laid out today regarding the credit card companies. I have to tell you, I feel like I am semi-sophisticated--semi--and I get incredibly confused by all these things I get in the mail, and candidly, throw most of them in the trash. I just don't understand. So the marketing practices, I think, are things that need to be looked at. So the only thing I would say is that we have this rule of unintended consequences that continues to sort of haunt us with actions that we take. While I think that certainly there have been abuses in fairness, at the same time, I think we have to be very careful. It seems that when we do things like this, in many cases, it is the lowest-income people that end up getting hurt the worst by our good efforts by virtue of having a lack of availability of credit. So I hope as we move through this, we will do this in a balanced way that does take into account some of the concerns that have been raised and I think are very fair. But at the same time, we understand that at the end of the day, these businesses are going to do those things in their self-interest, and when they do that, it may, in fact, end up harming the very people that this legislation is intended to help. So thank you very much for this great hearing. " FOMC20080130meeting--339 337,MS. HIRTLE.," Mike has described how the rating agencies treated structuredcredit products; a closely related issue is how investors used these ratings. Did investors rely too much on ratings in making their investment decisions? Did they take false comfort from ratings and not really appreciate the risks they were assuming, leading to excessive growth of the market for subprime structured credit? As noted in the top panel of exhibit 7, our approach was to examine these questions through the lens of one representative type of institutional investor: public pension funds. Public pension funds are an informative example of investor use (and misuse) of credit ratings for several reasons. First, public pension boards of directors are composed largely of representatives of the employees and retirees covered by the pension plan and have only limited financial expertise in some cases. Second, survey evidence suggests that a high portion of these funds use credit ratings in their investment guidelines. Finally, relative to some other investors, many public pension funds provide significant public information about their activities. While we need to be cautious in generalizing, we believe that practices in the pension fund sector reflect the tensions faced by other institutional investors in making risk assessments and investment decisions. We examined the investment practices and fund governance of 11 public pension plans. These plans ranged from the largest fund--CalPERS, with $250 billion in assets--to six much smaller plans with assets of $6 billion to $11 billion. We used the funds' 2006 comprehensive annual financial reports, which were generally the most recent available, and the funds' websites to generate our information. We focused specifically on the funds' fixed-income segments, since this is the asset class in which structured-credit products would likely be held and for which credit ratings are used. The middle panel lists some key conclusions from this review. The first is that these funds have developed workable market solutions to address inexperience or lack of financial sophistication among their managers and board members. These include hiring professional investment managers to make investment decisions on their behalf and, perhaps as significantly, hiring investment consultants to structure asset-allocation strategies, to select investment managers and develop mandates guiding their actions, and to monitor and assess fund performance. While these funds clearly obtain significant professional advice in managing their investments, our review suggests several ways in which these arrangements could be improved in light of recent financial innovation. Specifically, the mandates guiding investment managers have not always kept pace with the growth of structured-credit markets. These mandates typically require managers to meet or exceed returns on a benchmark index or of a peer group of investment managers, while constraining the risk the managers may assume. Credit ratings play an important role in these risk constraints--for instance, by imposing a minimum average rating for the portfolio or a minimum rating on individual securities. However, few of the funds we profiled made significant distinctions between structured-credit and other securities in these credit-rating-based constraints, although there were sometimes other limits on the aggregate share of asset-backed positions. The failure to make this distinction provides scope for investment managers to generate higher returns by moving into structured-credit products, without raising warning signals about the additional risk these positions entail. This is not necessarily a ""na�ve"" use of credit ratings by investment managers, as they could well have recognized that higher-yielding structured-credit products embodied significant additional risk relative to similarly rated corporate debt. Instead, it reflects a previously effective mechanism used by fund boards to convey risk appetite to these managers falling out-of-date with the emergence and rapid growth of a new form of credit instrument. As indicated in the bottom panel, our key recommendation is that the pension fund industry and other investors should re-evaluate the use of credit ratings in investment mandates. In a narrow sense, these mandates should distinguish between ratings on structured credit and those on more traditional corporate credit. However, the more fundamental point is that mandates would do a better job of enforcing desired risk limits on the overall portfolio if they acknowledged differences in risk, return, and correlation across instruments rather than relying on generic credit ratings. A second important point is that investors should ensure that their investment consultants have independent views of the quality and adequacy of credit ratings for the types of positions in their portfolios. This is particularly important if mandates guiding investment manager behavior feature credit ratings as a key risk constraint. That completes our prepared remarks. We would be happy to take your questions before we proceed to the final presentation. " FOMC20060629meeting--73 71,MR. MOSKOW.," Thank you, Mr. Chairman. Since our last meeting, uncertainty about the outlook for both growth and inflation has increased. Clearly the inflation data are disappointing, but let me first focus on economic growth. Here the key question is how much of the second-quarter weakness is transitory and how much represents a more fundamental softening in activity. So with regard to the consumer, we share the Greenbook’s assessment that increases in consumer expenditures will recover somewhere close to a rate of 3 percent in the second half of this year. Qualitatively, this seems to be the assessment of our contacts as well. One, a major builder and operator of shopping malls throughout the United States, said that retailers at malls have been quite pleased with the first five months of the year. Although they are expecting slower growth in the second half, they did not think that the falloff would be very large. The automakers report that June sales are relatively soft but better than in May, and they kept their forecast for light vehicles for the year as a whole around 16.6 million or 16.7 million units, which means they expect the second half of the year to be similar to the first half. This was also the consensus of the twenty-four industry analysts at our annual Automotive Outlook Symposium that we held last month. Looking at the fundamentals, like the Greenbook we think that growth in real income will be adequate to support the projected pace of spending. Under the baseline path for oil prices, energy prices should turn from a negative to a neutral factor for real income growth, though this is certainly an area of great uncertainty. Also, tight labor markets should eventually generate somewhat larger increases in wages, which should help offset the effects on overall income growth of somewhat slower gains in employment. Here I should note that we do not think that the recent slowdown in job growth is the start of a deterioration in the labor market. Our contact at Manpower studied this issue recently in response to skeptical Wall Street analysts who thought that the labor market was softening and that this would be reflected in a weakening temp sector. He studied forty major markets and found no signs of cutbacks in hiring plans by his customers, and his business continues to grow at a modest pace. Given our view of the trends in participation rates and other factors, we think that the 100,000 per month gains in payroll employment that we have seen over the past couple of months are consistent with an economy growing near potential, hence with little change in labor market slack. Of course, housing markets are weakening. At the last meeting we were more pessimistic than the Greenbook. This time, with its large revision, the Greenbook is slightly more pessimistic than we are. However, the overall negative tone of the Greenbook seems a bit puzzling to me given the current conditions that we were discussing earlier. After all, mortgage rates are not that high. The rate of house-price appreciation has not come down more than we expected. Still, current conditions are softening. A contact from a major national builder, Pulte Homes, told us that their new orders had dropped sharply and that the current high level of construction is being supported by working off backlogs. Accordingly, he expected a more marked slowdown in building in 2007. In the business sector, the reports from the manufacturers outside autos were, in general, very upbeat. Most indicated that orders and backlogs for investment goods were quite high. One of my directors, who is from a large, diversified manufacturing firm and who has always been cautious about future capital spending, said that demand for long-lead-time capital goods now is as strong as he has seen in his thirty years in business. And the pickup in nonresidential construction is partially offsetting the weaker activity on the residential side. Finally, financial conditions continue to be favorable. Indeed, given the recent increases in inflation, real short-term interest rates are in the middle of the neutral range, as shown in the Bluebook. Long-term borrowing costs are relatively low, and we still hear that there’s a lot of liquidity flowing through the financial system. So we think the outlook for business investment looks solid and somewhat stronger over the course of ’06 than the Greenbook forecast. To summarize our outlook for real activity, we think that the economy has somewhat stronger underlying momentum than the Greenbook does, and we are looking for growth at a pace of around 3 percent in the second half of this year. With regard to inflationary pressures, many of our contacts expressed concerns about input costs. We heard numerous reports this round of manufacturers that were passing on material cost increases to their customers. In the Chicago Purchasing Managers Survey, which will be released this Friday, the prices-paid component shot up from 76.9 in May to 89.0 in June, and the overall index moved down from 61.5 to 56.5. Capacity constraints also appear to be more common. For example, given industry consolidation, airline load factors are very high, and one major carrier indicated that it had been able to increase prices more than enough to cover higher fuel costs. We also received some reports that shortages of skilled labor were holding back production. Still, there were few signs of accelerating wage pressures. Of course, the incoming data on consumer prices have been disappointing, as Jeff Lacker just said, and as a result our indicator model’s forecasts of core PCE inflation in ’06 were revised up about 0.3 percentage point, to between 2.4 and 2.6 percent. The higher projection is from the model estimated using data since 1967; the lower number is from the estimates using data only since 1984. We think inflation this year will come in closer to the 2.4 percent figure as some of the cost pass- through that has already boosted prices runs its course. Looking to ’07, the model’s projections rose a tenth or two from the previous forecasts. The prediction using the post-1984 sample is 2.1 percent, whereas the long sample projection is 2.6 percent. So in the absence of some good news on the energy or materials costs front, I do not think that inflation will be headed into the bottom half of that range unless growth next year comes in a good deal below potential. At 3 percent, my forecast for GDP growth in ’07 is a bit below potential. My forecast for PCE inflation is 2.3 percent. This outlook is conditioned on my view of appropriate policy, which is a slightly higher path for the funds rate than currently built into the Greenbook because I feel that 2.4 percent inflation is too high, so I assumed that appropriate policy should attempt to arrest this acceleration." CHRG-111shrg57322--675 Mr. Viniar," I think there would be significantly less credit in the market because people would not want to take exposures to various companies, be it in mortgages, be it in credit products, be it in equities. People would have no ability to manage their risk, and so I think rather than reducing risk through offsetting longs with shorts, you just wouldn't have the longs, and so there would be much less credit provided. Senator Coburn. And if a shareholder looked at Goldman and said, you all had the ability to go short, you had the research that said you should go short, and that you didn't go short, could they hold you liable? In other words, could somebody have a basis for a suit against Goldman if you, through your research and through managing your risk, you passed up an opportunity to improve the shareholder value of Goldman? " CHRG-111hhrg48875--39 Mr. Lance," Thank you, Mr. Chairman. Good morning to you, Mr. Secretary. Let me say from my perspective, I wish the President well, and I wish you well in your incredibly responsible positions and I certainly wish you well next week in London. My questioning regards two matters in your testimony, credit default swaps and other OTC derivatives and money market mutual funds. You indicate, regarding credit default swaps, that in our proposed regulatory system, the government will regulate the markets for credit default swaps and over-the-counter derivatives for the first time. Mr. Secretary, can that be done by regulation, or will that require statutory change, and does it also require regulation or statutory change in London and in Asia and in other places in the world? " CHRG-109hhrg23738--74 Mr. Greenspan," Yes. I would certainly say this, that this issue has to be resolved. I mean, it cannot fester, because I think we will have some serious consequences. It has not, really, yet, but it could. And I do not deny that where issues of legality are involved statutes are required for clarification and understanding whose rights are in what particular area. I have heard some incredibly complex stories of people who, for example, had outsourced certain types of projects with a huge number of names which they had collected which got lost, and they are responsible. So the question of ``Who is legally responsible under those sorts of conditions?'' is a critical issue which the law has to address. I am just basically saying what I am a little concerned about, is that we all of a sudden have this major advance in technology--which is the whole electronic system--and that it is making major incursions into many areas where huge progress is occurring, and I am a little worried that we will stifle the process if we overdo it. But if you are getting at the issue on responsibility, on who has responsibility in the event of event X---- " CHRG-111shrg56376--207 Chairman Dodd," Well, thank you for that observation. I want to make the point, I just mentioned to Senator Merkley as he was walking out, I heard him say credit unions. Credit unions are not part of this consideration at all. We are talking about banks. And before we start getting inundated with e-mails and messages from across the country, credit unions, you are OK on this. [Laughter.] " FOMC20080916meeting--155 153,MR. KROSZNER.," Thank you very much. Since the last meeting, there have obviously been a number of flare-ups in the fires that have been burning in the financial markets--the GSEs and then certainly what's come this past weekend and what's likely to come over this week and into the future. A number of people have mentioned things ranging from AIG to pressures on money market funds to some large financial institutions. There are some very large regional banks and a very large thrift that will be facing a lot of challenges as the uncertainties in the markets continue. I won't repeat what Governor Kohn said about the continuing pressures on the bank balance sheets. I think it is important to take into account that those pressures will be there going forward not only on U.S. institutions but also increasingly on international institutions. No one has mentioned UBS yet, but that's another institution about which there's a lot of concern, and if you look at CDS quotes there, they are skyrocketing also. Much as Governor Warsh said, I think that people are worried about what the next shoe to drop will be and whom we have to challenge. Whom do we have to get more information about to make us feel comfortable? If that suddenly becomes everyone, then of course the markets don't function. I just want to focus quickly on consumption and consumer credit markets and then on inflation, and then I'll conclude. We have made some references to how consumers have acted in the past and whether they will continue to act this way. In some sense the consumer has been on a marathon since the early 2000s, facing an incredible amount of shocks--a lot of contraction in 2001, significant declines in stock market wealth, September 11, corporate governance scandals, sustained job losses, and low real income growth. Nonetheless, the consumer continued to consume. But now the consumer seems to be flagging. We have perhaps a very modest effect of the stimulus, which obviously can lead to negative payback for the rest of the year--so a drag going forward as well as drags from housing and stock market wealth, continuing job losses, rising unemployment, and pressures on income. Although many of these shocks were similar to ones that happened earlier in the decade, it seems that consumers do not have the same resilience now that they did at one point. It's not surprising that, after having run this marathon, they're going to be a bit tired. Part of it could also be the credit conditions that are putting much more pressure on them. Just to give you an anecdotal report, but it's from one of the largest providers of consumer credit in the economy. After stabilization basically through our FOMC meeting in August, we've seen some significant deterioration in delinquencies and in the performance of those who get into delinquencies--they roll right to full chargeoff much more rapidly. So we have seen not exactly a qualitative change but a significant deterioration. Also, the ability to securitize credit cards has changed dramatically. After our having opened the window and the markets having opened up in the second quarter, they basically haven't been able to do anything in the third quarter, and that's before this weekend. Obviously that's not going to be helping them. Of course, there are some offsetting factors that can help the consumer. The very significant decline in mortgage rates has led to quite a response, according to this very large provider of consumer credit in the United States. The number of applications for mortgages, particularly for refis, has doubled over the last couple of weeks. So people do respond to prices, and that can help to ease some of their income burdens. Obviously, the reduction in energy prices and many food prices is helpful on that. But of course, what has been good news for U.S. consumers may not be good news for international consumers. As a lot of people have mentioned, the rest of the world is seeing a very significant slowdown. I think the elevated commodity prices had helped to mask a lot of the underlying fiscal and structural problems in these economies, actually much like rising housing prices in the United States had masked the problems in underwriting standards and what was going on in the mortgage market. So I think there are going to be significant challenges in a lot of countries around the world. The boost that we had earlier this year from the international sector is something we can't rely on. On inflation, we're heartened by some of the lower energy prices. But I want to relate one anecdote. In a meeting at the OECD, the CEO of one of the largest private oil producers in the world was asked what reference price he used because obviously he has to make tens of billions of dollars of decisions on investment and so they thought here's someone who would really have a good notion of what the price of oil would be going forward. Without hesitation the person responded, ""$100, plus or minus $50."" [Laughter] That kind of uncertainty from someone who is really in the markets and making those kinds of decisions shows us that we have a reasonable degree of uncertainty in inflation pressures going forward. That said, I think the Greenbook forecast is where I would be also, although we're at uncomfortably elevated levels now. There are a lot of reasons to believe that, although they may be even a bit more elevated in the coming quarter, there are likely forces to bring things back down. This is particularly credible in the context of both survey-based and market-based expectations being quite contained, the market-based expectations being at the low of the year or even over the last couple of years. So this brings me to support alternative B for no change today. On the statement, I do believe that some greater recognition of the stress would be valuable. I think it would be valuable to have something in the first sentence of paragraph 2 that focuses on the strains--perhaps just a single sentence about the strains--and then we can put the other pieces on consumption and housing into the next sentence. It is important in the final paragraph to leave our options open if we do see significant negative feedback effects so that we can make a move that wouldn't be a shock to the markets but it also wouldn't be something that the markets could bank on. Thank you, Mr. Chairman. " CHRG-111hhrg54873--20 Chairman Kanjorski," Thank you very much, Mr. Hensarling. Now, we will hear from the gentlelady from Ohio, Ms. Kilroy, for 2 minutes. Ms. Kilroy. Thank you, Mr. Chairman. Thank you for your leadership on this issue and for the opportunity to work with you and the task force on this very important issue. Credit rating agencies occupy a unique and powerful position within the global markets and reforming this industry is a critical part of strengthening our financial regulatory system. Like many of my House colleagues, I have firsthand experience with the role credit rating agencies play as gatekeepers to the financial markets. Before coming to this House, I served for 8 years as a Franklin County commissioner and also for 8 years on the Columbus board of education representing constituents of central Ohio and as a county commissioner, worked very hard to make our county fiscally responsible and to maintain our double, AAA rating. It is a rating that we worked hard to keep because we thought it had meaning and value, that it represented a seal of approval and that it would save our taxpayers their hard-earned money. Of course, as you know, the rise of credit rating agencies as financial gatekeepers began when the Securities and Exchange Commission in 1975 in what probably seemed like a benign move tied broker/dealer capital requirements to credit ratings issued by the nationally recognized statistical rating organization, a designation created and determined by the SEC. Since then, the credit rating agencies have experienced unprecedented growth. Even when the credit rating agencies seemed to get it all wrong, they did amazingly well, posting record profits at about the same time they were downgrading billions of dollars worth of subprime offerings. And it is not just that the rating agencies seemed to miss big. But now an infamous instant message exchange has been made public, instant messaging between two Standard & Poor's officials about a mortgage-backed security deal dated April 5, 2007, which seems to suggest that credit rating agencies can make billions of dollars to provide an opinion on just about anything with little fear of penalty or recourse and that exchange one analyst stated over a colleague's objections, ``We rate every deal. If it is structured by cows then we would rate it.'' And as recently as September 23, 2009, The Wall Street Journal reported that Moody's is still assigning inflated ratings to complicated debt securities that they still do not fully understand. I am a sponsor of this very important piece of legislation, because it is this cavalier culture made worse by a broken system that cost millions of hard-working Americans their live savings and set our Nation into the worst economic crisis since the Great Depression. Addressing the overreliance on NRSRO ratings and Federal statutes and regulations is a good place to start. Rating agencies should be a part of the equation when making investment decisions, not the equation. That is not to say that credit rating agencies do not provide value. For thousands of small investors, rating each and every security individually would be an impossible task. The proposal directs the SEC to adopt rating symbols to help the small investor distinguish between a municipal bond issue and a collateralized debt compromised of subprime mortgages that have been sliced and diced and repackaged into looking like a safe investment. Finally, the proposal seeks to deal with credit rating agencies that act with malfeasance. Credit rating agencies that knowingly or recklessly failed to conduct a reasonable investigation into the very ratings they were paid to provide an assessment on should not be allowed unfetterred constitutional protection. Thank you again, Mr. Chairman, for the opportunity, and I yield back. " CHRG-111shrg50815--2 Chairman Dodd," The Committee will come to order. My apologies to our witnesses and my colleagues. Today is the 200th anniversary of Abraham Lincoln's birthday and I took my daughter up to Lincoln's cottage this morning up at the Old Soldier's Home where there was a ceremony this morning to unveil a wonderful statue of Abraham Lincoln and his horse Old Boy that he used to ride every morning for about a quarter of his Presidency from the White House to the Old Soldiers Home where he lived for a quarter of that Presidency and he wrote the Emancipation Proclamation. So I thought I would take my daughter out of school this morning for a bit of history and I am sorry to be a few minutes late getting back here this morning, so apologies to everybody for being a few minutes late for enjoying a moment of history with a 7-year-old. Well, let me begin with some opening comments, if I can. I will turn to Senator Shelby. We are honored to have such a distinguished panel of witnesses with us this morning on an issue that many of my colleagues know has been a source of interest of mine for literally two decades, the issue of reform of the credit card industry. And so this hearing this morning will give us a chance to reengage in that debate and discussion, and I want my colleagues to know at some point, and I say this to my good friend, the former Chairman of the Committee, at some point, I would like to be able to mark up a bill in this area. I know he knows that, but I wanted to say so publicly. So good morning to everyone, and today the Committee meets to look into an issue of vital importance to American consumers, their families, and to the stability of our financial system, and that is the need to reform the practices of our nation's credit card companies and to provide some tough new protections for consumers. In my travels around my State, as I am sure it is true of my colleagues, as well, we frequently hear from constituents about the burden of abusive credit card practices. In fact, the average amount of household credit card debt in my State is over $7,100. Actually, the number is higher, I think, nationally. Non-business bankruptcy filings in the State are increasing. In the second quarter of last year, credit card delinquencies increased in seven of eight counties in my State. Across the country, cardholders are paying $12 billion in penalty fees annually, every year. It is a major problem throughout our nation. At a time when our economy is in crisis and consumers are struggling financially, credit card companies in too many cases are gouging, hiking interest rates on consumers who pay on time and consistently meet the terms of their credit card agreements. They impose penalty interest rates, some as high as 32 percent, and many contain clauses allowing them to change the terms of the agreement, including the interest rate, at any time, for any reason. These practices can leave mountains of debt for families and financial ruin in far too many cases. When I introduced Secretary Geithner earlier this week as he unveiled the framework of the President's plan to stabilize our financial system, I noted then for too long, our leading regulators had failed fully to realize that financial health and security of the consumers is inextricably linked to the success of the American economy. In fact, for too many years, I think people assumed that consumer protection and economic growth were antithetical to each other. Quite the opposite is true. I noted that unless we apply the same urgent focus to helping consumers that we apply to supporting our banks' efforts to restart lending, we will not be able to break the negative cycle of rising foreclosures and declining credit that is damaging our economy. In this hearing, the Committee examines abusive credit card practices that harm consumers and explores some very specific legislative ideas to end them. These kinds of consumer protections must be at the forefront of our efforts to modernize our financial regulatory system. Why is this both important and urgent? Well, today, far too many American families are forced to rely on short-term, high-interest credit card debt to finance their most basic necessities. And as layoffs continue, home values plunge, and home equity lines of credit are cut or canceled, they are increasingly falling behind. This December, the number of credit card payments that were late by 60 days or more went up 16.2 percent from last year. Banks increasingly worried about taking more debt, bad debt, into their balance sheets are monitoring their credit card portfolios very closely, slashing credit lines and increasing fees and interest rates even more for consumers who have held up their end of the bargain. That puts consumers, including many of my constituents and others around the country, in the worst possible position at the worst possible time. For too long, the use of confusing, misleading, and predatory practices have been standard operating procedures for many in the credit card industry. The list of troubling practices that credit card companies are engaged in is lengthy and it is disturbing: Predatory rates, fees, and charges; anytime, any reason interest rate increases and account charges; retroactive interest rate increases; deceptive marketing to young people; shortening the period consumers have to pay their bills with no warning. Even the Federal financial regulators, of whom I have been openly critical for a lack of appropriate oversight throughout this subprime mortgage market crisis, recognize the harm these sinister practices pose not only to credit card customers, but also to our economy. Last May, the Federal Reserve, the Office of Thrift Supervision, and the National Credit Union Administration proposed rules aimed at curbing some of these practices. These rules were a good step and I applaud them, but they are long overdue. But they fell far short of what is actually needed, in my view, to protect American families. Just as we have seen in this housing crisis, when companies lure people into financial arrangements that are deceptive, abusive, and predatory, it only means mountains of debt for families, bankruptcy, and financial ruin for far too many. It also proved catastrophic, of course, for our economy. Today as the Committee examines how best to modernize and reform our outdated and ineffective financial regulatory system, we have a clear message to send to the industry. Your days of bilking American families at the expense of our economy are over. Today, we will discuss proposals to reform abusive credit card practices that drag so many American families deeper and deeper and deeper into debt, including the Credit Card Accountability, Responsibility, and Disclosure Act, which I recently reintroduced. We must protect the rights of financially responsible credit card users so that if a credit card company delayed crediting your payment, you aren't charged for this mistake. We must prevent issuers from changing the terms of a credit card contract before the term is up. And perhaps most importantly, we must protect our young people who are faced with an onslaught of credit card offers, often years before they turn 18, or as soon as they set foot onto a college campus. These practices are wrong and they are unfair. And mark my words, in the coming months, they are going to end. Of course, we must do all we can to encourage consumers to also act responsibly when it comes to using credit cards. But we should demand such responsible behavior when it comes to the companies that issue these cards, as well. The need to reform credit card practice has never been more important. It is not only the right thing to do for families and our consumers, it is the right thing to do for our economy, as well. I have been working on reforms in this area for many, many years and I am determined to move forward on these reforms. With that, let me turn to our former Chairman and Ranking Member, Richard Shelby. CHRG-111shrg56415--6 ADMINISTRATION Ms. Matz. Thank you, Chairman Johnson, Senator Crapo, and members of the Subcommittee. I am pleased to provide NCUA's views on the state of the industry. As you have heard from my counterparts, the stress on the entire financial sector has translated into a challenging time for financial institutions, including credit unions. Nonetheless, I am confident that credit unions can and will weather the storm. Corporate credit unions pose the most serious challenges to the credit union industry. Corporate credit unions are wholesale credit unions created by retail credit unions to provide investment services, liquidity, and payment systems. For four decades, this system worked well. However, in 2008, corporate exposure to mortgage-backed securities created tangible liquidity difficulties. In response to a growing crisis, NCUA asked Congress to increase the borrowing ceiling on our back-up liquidity source--the Central Liquidity Facility. Congress granted NCUA's request, and it is clear to me that if you had not acted in such a swift and decisive manner, the entire credit union system, not just the corporate network, would have been in serious jeopardy. Despite this successful intervention, problems continued. In March, the two largest corporates were placed into conservatorship by NCUA due to the deterioration in their portfolios. Losses flowed through the system and resulted in writedowns of capital not only by other corporates but by retail credit unions that invested in these institutions. Given the tenuous real estate market, NCUA expects additional losses to materialize. These conservatorships permit the corporate system to continue to function and to serve retail credit unions and, most importantly, their 90 million members. Again, a mechanism was developed, the Corporate Credit Union Stabilization Fund, which permitted replenishment by the industry over a 7-year period. This spreading out of costs was critical as credit union earnings were already experiencing pressures. The Corporate Stabilization Fund has permitted NCUA to maintain its mandated equity ratio in the Share Insurance Fund. At no point during this crisis has the equity ratio fallen below the 1.2 percent established by Congress, and today it stands at 1.3 percent, assuring consumers that their insured deposits are safe. Retail credit unions have their own challenges independent of the corporates. The good news is that, despite the troubled economy, credit union lending has increased by almost 8 percent since 2007. However, delinquencies and loan losses have also increased, particularly in real estate lending. In 2007, about 0.3 percent of such loans were delinquent. The figure now stands at 1.62 percent. Industry-wide capital, while still strong, has declined from 11.8 percent in 2007 to 10 percent. On the one hand, I am encouraged by the fact that 98 percent of the 7,700 federally insured credit unions are at least adequately capitalized. On the other hand, 21 credit unions have failed so far this year compared to 18 in all of 2008. That number could well rise in 2010. Most troubling is the increase in credit unions which have been downgraded to CAMEL 4 and 5. Between December 2008 and August 2009, the assets of credit unions in these categories have almost doubled. Clearly, credit unions have not been spared from the harsh effects of the economic downturn. In tandem with the assessment of corporate losses described above, this presents a difficult road for credit unions to travel in 2010 and beyond. NCUA has been proactive in our efforts to mitigate the situation. NCUA examiners work with credit unions to avoid the riskiest types of mortgage lending, and this oversight was complemented by the fact that, as member-owned cooperatives, credit unions try to put their members into lending products they can afford. As a result, the industry largely steers clear of exotic mortgage lending. Only 2.3 percent of all credit union mortgage loans are exotic. Additionally, NCUA has enhanced our supervision. We shortened our examination cycle. We added 50 examiners in 2009 and anticipate adding 57 more in 2010, and we upgraded our risk management system to identify and resolve problems more quickly. NCUA has an obligation to consumers. As a safety and soundness regulator, we will be successful if we preserve strong credit unions capable of meeting the financial needs of their members. Credit union members rightfully expect a reliable and well-capitalized deposit insurance regime. While the year ahead will be challenging, I am confident that we and the credit union industry we regulate will be stronger in the end. I welcome the opportunity to answer your questions. Senator Johnson. Thank you, Ms. Matz. " Mr. Ward," STATEMENT OF TIMOTHY T. WARD, DEPUTY DIRECTOR, EXAMINATIONS, CHRG-111shrg56262--89 PREPARED STATEMENT OF CHAIRMAN JACK REED I want to welcome everyone and thank our witnesses for appearing today. This hearing will examine a key activity within our financial markets--the securitization of mortgages and other assets--and will build on previous hearings this Subcommittee has held to address various aspects of regulatory modernization, including hedge funds, derivatives, corporate governance, SEC enforcement, and risk management at large financial institutions. Securitization is the packaging of individual loans or other debt instruments into marketable securities to be purchased by investors. At its core, this process helps free lenders to make more loans available for families to purchase items like homes and cars and for small businesses to thrive. But we have learned from the financial crisis that securitization, or how it is conducted, can also be extremely harmful to financial markets and families without appropriate diligence and oversight. Arguably, many of the basic requirements needed for effective securitization were not met. Today's panel will discuss how in recent years the securitization process created incentives throughout the chain of participants to emphasize loan volume over loan quality, contributing to the build-up and collapse of the subprime mortgage market and the broader economy. Today we find ourselves in the opposite position from a few years back, with hardly any issuances in key markets that could help return lending to responsible levels. So this afternoon's hearing is about how to strengthen the securitization markets and enact any needed changes to ensure that securitization can be used in ways that expand credit without harming consumers and the capital markets. I have asked today's witnesses to address a number of key issues, including the role securitization played in the financial crisis, the current conditions of these markets, and what changes may be needed to Federal oversight of the securitization process. Unfortunately, a number of the banks who issue these securities could not find anyone in their workforce who was willing to testify today. I welcome you all and look forward to your testimony. ______ FOMC20060629meeting--109 107,MR. KOHN.," Thank you, Mr. Chairman. Incoming data have tended to confirm to a degree both the downside risks to growth and the upside risks to core inflation that we’ve been talking about at recent meetings. Higher inflation interacting with policymaker comments on the inflation situation triggered higher expected real interest rates and more uncertainty about the longer-term future. That in turn further tightened financial conditions, leading to more markdown of growth prospects. Notably, the worry about added inflation pressures has not been confined to the United States, given strong growth abroad, high energy and commodity prices, and a sense that output is close to potential. Widespread policy tightening and greater uncertainty have led to increased caution on the part of investors and tighter global financial conditions. The incoming data certainly have influenced my projections—I expect less growth and more inflation than I did a few months ago. I’m also even less confident, if that’s possible, than I was given these surprises. The key question in my mind is whether the conditions are in place or soon will be in place—that is, after tomorrow—to keep core inflation at considerably lower levels than it has been so far this year. I think they are, and in this regard I’m a touch more optimistic than the staff. I have slightly lower inflation for 2007 with the same policy assumption. Most important, I don’t believe that the extra inflation we’ve had results from the economy producing beyond its long-run potential. We obviously can’t be very confident about this. The decline in the unemployment rate to noticeably below 5 percent occurred only at the beginning of this year, but the behavior of compensation last year and this year suggests to me that the NAIRU is more likely to be under than to be over 5 percent. Perhaps better job- matching through Internet search, declining real minimum wages, and lingering worker insecurity, after the only-moderate increase in employment early in this expansion, have lowered the NAIRU a touch. We should expect compensation growth to pick up as in the staff forecast, but the implications of this pickup for inflation are unclear, given elevated profit margins and what is likely to be a competitive business environment. I do think relative price adjustments are playing an important role in what we’ve been seeing. I suspect I have been implicitly underestimating the effect of higher energy prices on both output and inflation. Before this year, the effect of rising energy prices on inflation was offset by slack in the economy, and the effect on activity was offset by easing monetary policy that was put in place to counter that slack. With both slack and easing policy disappearing, the effects of higher energy prices are showing through in both output and inflation. Another adverse price shock seems to be coming from the housing market, where the previous run-up in prices and the higher interest rates are weakening prospects for home price appreciation. This weakening, in turn, is both reducing activity and raising actual and imputed owners’ equivalent rents. The longer-term inflation effects of both these relative price changes will depend on their persistence and their propagation into other prices. In this regard, President Poole, I see us as perhaps accommodating the first-round effects of the increase in prices but making sure they don’t propagate beyond that, rather than having a price-level target that would bring us back down to the old price level. With regard to persistence, petroleum prices have leveled out since April, and futures markets don’t suggest further increases. It’s difficult to get much of a fix on future rent increases, as prices and rents realign to higher interest rates and lower expected capital gains. In the past, most of that realignment has come through prices; but we don’t have many observations, and the required adjustment appears much larger this time. There are two keys to preventing the relative price changes from becoming embedded in broader and more persistent inflation: low inflation expectations and a competitive business environment. If energy prices do flatten out, headline inflation will come down, and I think that will help to contain the inflation expectations of households and businesses and bring down core inflation. The propagation of higher rates of increase in rents, should they persist, to other prices I found much harder to analyze. After all, homeowners are, in effect, paying themselves higher imputed prices, and it’s not clear that they would change their behavior in labor markets to expect higher wages as a result. Moreover, with respect to owners’ equivalent rent, I think our usual financial market measures of inflation expectations may not be reliable indicators of behavioral shifts. Expected persistent increases in owners’ equivalent rent will boost expected CPI showing up in TIPS spreads but not necessarily affecting other pricing decisions. A persistence of elevated rent increases will put a premium on viewing their implications for future inflation rather than on simply reacting to the incoming data. The competitive environment will depend largely on the degree of resource utilization. In this regard, the negative effects of the oil and housing market developments on activity, along with the tightening in financial conditions, suggest that activity could well run at least a little below the rate of growth of potential for the next several quarters. That will help to limit longer-run inflation pressures. In a sense, the forces that seem to be pushing up inflation are also contributing to the conditions that should hold it in check. In sum, recent inflation data have been an unpleasant surprise, but the source of the price increases—that is, price shocks, not overshooting—and the economic conditions coming into place should imply a softening of core inflation over the next 1½ years. This outcome is based on the assumption that the relative price increases don’t become more broadly embedded in other prices and second-round effects. We’ll talk tomorrow about how policy might contribute to reducing the odds of that possibility. Thank you, Mr. Chairman." CHRG-110shrg50420--261 Mr. Wagoner," Our proposal comprehends the idea of this Federal oversight board. I realized there was some concern with the naming of that, but obviously highly empowered board. We would submit the plan with a timeframe. The board would play an active role as the funding would be doled out only gradually, and then if by a date certain--and March 31st I think would be a good one to work with--we cannot get the parties together, then additional funding would not be advanced, and we could provide collateral against the loans---- Senator Crapo. Would your idea with regard to this board include the board having the authority to impose restructuring conditions on various parties? " FOMC20080916meeting--42 40,MR. DUDLEY.," In principle, we could talk to the ECB and other central banks about having the rate on these swap lines be at a slight penalty relative to normal times to try to mitigate the potential reserve impact. I mean, it doesn't have to be at 2 percent or 2� percent for overnight funds--it could be somewhat north of that. But if we have a credible backstop, then it should calm the markets, and then the backstop should not be used. If we have a backstop and it actually is used, that is presumably because market conditions are horrific. So in that environment, you could argue that the reserve-management things are very second order concerns in some sense. " CHRG-111shrg57321--120 Mr. Raiter," But the other side of it is, in all candor--and I do not want to get into an analytical debate. But when you have pools coming in with 1,000 to 10,000 loans, each one with about 85 to 100 data points, it is difficult to have an individual sit there and look at a printout and come up with some qualitative decision on what is a five-basis-points difference in enhancement at the AAA. You cannot do these products without models. And if there is an area that you might address, the Fair Credit Reporting Act prevents the rating agencies from getting the kind of in-depth information on borrowers that would help them gauge the credit performance expectations. Senator Kaufman. Right. " CHRG-111shrg57923--43 PREPARED STATEMENT OF DANIEL K. TARULLO Member, Board of Governors of the Federal Reserve System February 12, 2010 Chairman Bayh, Ranking Member Corker, and other members of the Committee, thank you for inviting me to testify today. I also want to thank all of you for taking the time to explore a subject that is easily overlooked in the public debate around financial reform, but that will be central to ensuring a more stable financial system in the future. The recent financial crisis revealed important gaps in data collection and systematic analysis of institutions and markets. Remedies to fill those gaps are critical for monitoring systemic risk and for enhanced supervision of systemically important financial institutions, which are in turn necessary to decrease the chances of such a serious crisis occurring in the future. The Federal Reserve believes that the goals of agency action and legislative change should be (1) to ensure that supervisory agencies have access to high-quality and timely data that are organized and standardized so as to enhance their regulatory missions, and (2) to make such data available in appropriately usable form to other government agencies and private analysts so that they can conduct their own analyses and raise their own concerns about financial trends and developments. In my testimony this morning I will first review the data collection and analysis activities of the Federal Reserve that are relevant to systemic risk monitoring and explain why we believe additional data should be collected by regulatory authorities with responsibility for financial stability. Next I will set forth some principles that we believe should guide efforts to achieve the two goals I have just noted. Finally, I will describe current impediments to these goals and suggest some factors for the Congress to consider as it evaluates potential legislation to improve the monitoring and containment of systemic risk.The Federal Reserve and Macro-Prudential Supervision The Federal Reserve has considerable experience in data collection and reporting in connection with its regulation and supervision of financial institutions, monetary policy deliberations, and lender-of-last-resort responsibilities. The Federal Reserve has made large investments in quantitative and qualitative analysis of the U.S. economy, financial markets, and financial institutions. The Federal Reserve also has recently initiated some new data collection and analytical efforts as it has responded to the crisis and in anticipation of new financial and economic developments. For supervision of the largest institutions, new quantitative efforts have been started to better measure counterparty credit risk and interconnectedness, market risk sensitivities, and funding and liquidity. The focus of these efforts is not only on risks to individual firms, but also on concentrations of risk that may arise through common exposures or sensitivity to common shocks. For example, additional loan-level data on bank exposures to syndicated corporate loans are now being collected in a systematic manner that will allow for more timely and consistent measurement of individual bank and systemic exposures to these sectors. In addition, detailed data obtained from firms' risk-management systems allow supervisors to examine concentration risk and interconnectedness. Specifically, supervisors are aggregating, where possible, the banks' largest exposures to other banks, nonbank financial institutions, and corporate borrowers, which could be used to reveal large exposures to individual borrowers that the banks have in common or to assess the credit impact of a failure of a large bank on other large banks. Additional time and experience with these data will allow us to assess the approach's ability to signal adverse events, and together they will be a critical input to designing a more robust and consistent reporting system. Furthermore, we are collecting data on banks' trading and securitization risk exposures as part of an ongoing, internationally coordinated effort to improve regulatory capital standards in these areas. Moreover, analysis of liquidity risk now incorporates more explicitly the possibility of marketwide shocks to liquidity. This effort also is an example of the importance of context and the need to understand the firms' internal risk models and risk-management systems in designing data collection requirements. Data that only capture a set of positions would not be sufficient since positions would not incorporate behavioral assumptions about firms, based on information about firms' business models and practices. The Federal Reserve's responsibilities for monetary policy are also relevant for systemic risk monitoring. Systemic risk involves the potential for financial crises to result in substantial adverse effects on economic activity. As the nation's central bank, the Federal Reserve assesses and forecasts the U.S. and global economies using a wide variety of data and analytical tools, some based on specific sectors and others on large-scale models. In the wake of the crisis, research has been expanded to better understand the channels from the financial sector to the real economy. For example, building on lessons from the recent crisis, the Federal Reserve added questions to the Survey of Professional Forecasters to elicit from private-sector forecasters their subjective probabilities of forecasts of key macroeconomic variables, which provides to us, and to the public, better assessments of the likelihood of severe macroeconomic outcomes. The Federal Reserve has made substantial investments in data and analytical staff for financial market monitoring. Each day, the Trading Desk at the Federal Reserve Bank of New York analyzes and internally distributes reports on market developments, focusing on those markets where prices and volumes are changing rapidly, where news or policy is having a major effect, or where there are special policy concerns. Those analyses begin with quantitative data, supplemented with information obtained through conversations with market participants and reviews of other analyses available in the market. Over the past few years, the Desk has worked closely with our research staff in developing new quantitative tools and new data sources. This ongoing monitoring requires continual evaluation of new data sources and analytical tools to develop new data as new markets and practices develop. For example, information on market volumes and prices can be collected from new trading platforms and brokers, data on instruments such as credit default swaps, or CDS, are provided by vendors or market participants, and fresh insights are gained from new methods of extracting information from options data. In some cases, publication of data by the private sector may be mandated by legislation (such as, potentially, trade data from over-the-counter derivatives trade repositories); in other cases, the Federal Reserve or other government agencies or regulators require or encourage the gathering and publication of data. Our experiences with supervision, monetary policy, and financial market monitoring suggest that market data gathering and market oversight responsibilities must continuously inform one another. In addition, efforts to identify stresses in the system are not a matter of running a single model or focusing on a single risk. Rather, it is the assembly of many types of analysis in a systematic fashion. The Supervisory Capital Assessment Program (SCAP) for large financial institutions--popularly known as the ``stress test'' when it was conducted early last year--illustrates the importance of combining analysis by credit experts, forecasts and scenario design by macroeconomists, and hands-on judgments by supervisors in assessing the financial condition and potential vulnerabilities of large financial institutions. While considerable steps have been made in the wake of the financial crisis, the Federal Reserve intends to do a good deal more. The Federal Reserve also will continue to strengthen and expand its supervisory capabilities with a macroprudential approach by drawing on its considerable data reporting, gathering, and analytical capabilities across many disciplines. In the areas in which we are collecting data through the supervisory process on measures of interlinkages and common exposures among the largest financial firms we supervise, we are developing new analytical tools that may lead us to change our information requests from supervised firms. The Federal Reserve is exploring how to develop analytically sophisticated measures of leverage and better measures of maturity transformation from information that we can collect from the supervised firms in the supervisory process and from other available data and analysis. We envision developing a robust set of key indicators of emerging risk concentrations and market stresses that would both supplement existing supervisory techniques and assist in the early identification of early trends that may have systemic significance and bear further inquiry. This kind of approach will require data that are produced more frequently than the often quarterly data gathered in regulatory reports, although not necessarily real-time or intraday, and reported soon after the fact, without the current, often long, reporting lags. These efforts will need to actively seek international cooperation as financial firms increasingly operate globally.The Potential Benefits of Additional Data Improved data are essential for monitoring systemic risk and for implementing a macroprudential approach to supervision. The financial crisis highlighted the existence of interlinkages across financial institutions and between financial institutions and markets. Credit risks were amplified by leverage and the high degree of maturity transformation, especially outside of traditional commercial banking institutions. Moreover, supervision traditionally has tended to focus on the validity of regulated firms' private risk-management systems, which did not easily allow comparisons and aggregation across firms. One key feature of the recent crisis was the heavy reliance on short-term sources of funds to purchase long-term assets, which led to a poor match between the maturity structure of the firms' assets and liabilities. Such maturity transformation is inherently fragile and leaves institutions and entire markets susceptible to runs. Indeed, a regulatory, supervisory, and insurance framework was created during the Great Depression to counter this problem at depository institutions. However, in recent years a significant amount of maturity transformation took place outside the traditional banking system--in the so-called shadow banking system--through the use of commercial paper, repurchase agreements, and other instruments. Our ability to monitor the size and extent of maturity transformation has been hampered by the lack of high-quality and consistent data on these activities. Better data on the sources and uses of maturity transformation outside of supervised banking organizations would greatly aid macroprudential supervision and systemic risk regulation. Another feature of the recent crisis was the extensive use of leverage, often in conjunction with maturity transformation. The consequences of this combination were dramatic. When doubts arose about the quality of the assets on shadow banking system balance sheets, a classic adverse feedback loop ensued in which lenders were increasingly unwilling to roll over the short-term debt that was used as funding. Liquidity-constrained institutions were forced to sell assets at increasingly distressed prices, which accelerated margin calls for leveraged actors and amplified mark-to-market losses for all holders of the assets, including regulated firms. Here, too, government regulators and supervisors had insufficient data to determine the degree and location of leverage in the financial system. More generally, the crisis revealed that regulators, supervisors, and market participants could not fully measure the extent to which financial institutions and markets were linked. A critical lesson from this crisis is that supervisors and investors need to be able to more quickly evaluate the potential effects, for example, of the possible failure of a specific institution on other large firms through counterparty credit channels; financial markets; payment, clearing, and settlement arrangements; and reliance on common sources of short-term funding. A better system of data collection and aggregation would have manifold benefits, particularly if the data are shared appropriately among financial regulators and with a systemic risk council if one is created. It would enable regulators and a council to assess and compare risks across firms, markets, and products. It would improve risk management by firms themselves by requiring standardized and efficient collection of relevant financial information. It also would enhance the ability of the government to wind down systemically important firms in a prompt and orderly fashion by providing policymakers a clearer view of the potential impacts of different resolution options on the broader financial system. Additional benefits would result from making data public to the degree consistent with protecting firm-specific proprietary and supervisory information. Investors and analysts would have a more complete picture of individual firms' strengths and vulnerabilities, thereby contributing to better market discipline. Other government agencies, academics, and additional interested parties would be able to conduct their own analyses of financial system developments and identify possible emerging stresses and risks in financial markets. One area in which better information is particularly important is the web of connections among financial institutions though channels such as interbank lending, securities lending, repurchase agreements, and derivatives contracts. Regulators also need more and better data on the links among institutions through third-party sponsors, liquidity providers, credit-support providers, and market makers. Knowledge of such network linkages is a necessary first step to improve analysis of how shocks to institutions and markets can propagate through the financial system.Principles for Developing a System of Effective Data and Analytical Tools Moving from the recognition of the need for more data to an efficient data system is not an easy task. Data collection entails costs in collection, organization, and utilization for government agencies, reporting market participants, and other interested parties. Tradeoffs may need to be faced where, for example, a particular type of information would be very costly to collect and would have only limited benefits. The Internet and other applications of information technologies have made us all too aware of the potential for information overload, a circumstance in which relevant information is theoretically available, but the time and expense of retrieving it or transforming it into a usable form make it unhelpful in practical terms. Collection of more data just for its own sake also can raise systemic costs associated with moral hazard if investors view data collection from certain firms, products, and markets as suggesting implicit support. It is thus particularly worth emphasizing the importance of having data available readily and in a form that is appropriate for the uses to which it will be put. With these considerations in mind, we have derived a number of guiding principles for a system of new data and analytical tools for effectively supervising large institutions and monitoring systemic risk. First, the priorities for new data efforts should be determined by the nature of regulatory and supervisory missions. In particular, the data need to be sufficiently timely and to cover a sufficient range of financial institutions, markets, instruments, and transactions to support effective systemic risk monitoring and macroprudential supervision, as well as traditional safety-and-soundness regulation. The events of the past few years have painfully demonstrated that regulators, financial institutions, and investors lacked ready access to data that would have allowed them to fully assess the value of complex securities, understand counterparty risks, or identify concentrations of exposures. The data needed for systemic risk monitoring and supervision are not necessarily ``real-time'' market data--information about trades and transactions that can be reported at high frequency when the events occur--but certainly data would need to be ``timely.'' What is considered to be ``timely'' will depend on its purpose, and decisions about how timely the data should be should not ignore the costs of collecting and making the data usable. For many supervisory needs, real-time data would be impractical to collect and analyze in a meaningful way and unnecessary. For example, while supervisors may indeed need to be able to quickly value the balance sheets of systemically important financial institutions, very frequent updates as transactions occur and market prices change could lead to more volatility in values than fundamental conditions would indicate and would be extraordinarily expensive to provide and maintain. Certainly, real-time data could be needed for regulators responsible for monitoring market functioning, and daily data would be helpful to measure end-of-day payment settlements and risk positions among the largest firms. But for supervising market participants, real-time market data could require enormous investments by regulators, institutions, and investors in order to be usable while yielding little net benefit. As policymakers consider redesign of a system of data collection, the goal should be data that are timely and best suited to the mission at hand. A second principle is that data collection be user-driven. That is, data on particular markets and institutions should be collected whenever possible by the regulators who ultimately are responsible for the safety and soundness of the institutions or for the functioning of those markets. Regulators with supervisory responsibilities for particular financial firms and markets are more likely to understand the relevance of particular forms of standardized data for risk management and supervisory oversight. For example, supervisors regularly evaluate the ability of individual firms' own risk measures, such as internal ratings for loans, and of liquidity and counterparty credit risks, to signal potential problems. As a result, these supervisors have the expertise needed to develop new reporting requirements that would be standardized across firms and could be aggregated. Third, greater standardization of data than exists today is required. Standardized reporting to regulators in a way that allows aggregation for effective monitoring and analysis is imperative. In addition, the data collection effort itself should encourage the use of common reporting systems across institutions, markets, and investors, which would generally enhance efficiency and transparency. Even seemingly simple changes, such as requiring the use of a standardized unique identifier for institutions (or instruments), would make surveillance and reporting substantially more efficient. Fourth, the data collected and the associated reporting standards and protocols should enable better risk management by the institutions themselves and foster greater market discipline by investors. Currently, because the underlying data in firms' risk-management systems are incomplete or are maintained in nonstandardized proprietary formats, compiling industry-wide data on counterparty credit risk or common exposures is a challenge for both firms and supervisors. Further, institutions and investors cannot easily construct fairly basic measures of common risks across firms because they may not disclose sufficient information. In some cases, such as disclosure of characteristics of underlying mortgages in a securitized pool, more complete and interoperable data collection systems could enhance market discipline by allowing investors to better assess the risks of the securities without compromising proprietary information of the lending institution. Fifth, data collection must be nimble, flexible, and statistically coherent. With the rapid pace of financial innovation, a risky new asset class can grow from a minor issue to a significant threat faster than government agencies have traditionally been able to revise reporting requirements. For example, collateralized debt obligations based on asset-backed securities grew from a specialized niche product to the largest source of funding for asset-backed securities in just a few years. Regulators, then, should have the authority to collect information promptly when needed, even when such collections would require responses from a broad range of institutions or markets, some of which may not be regulated or supervised. In addition, processes for information collection must meet high standards for reliability, coherence, and representativeness. Sixth, data collection and aggregation by regulatory agencies must be accompanied by a process for making the data available to as great a degree as possible to fellow regulators, other government entities, and the public. There will, of course, be a need to protect proprietary and supervisory information, particularly where specific firm-based data are at issue. But the presumption should be in favor of making information widely available. Finally, any data collection and analysis effort must be attentive to its international dimensions and must seek appropriate participation from regulators in other nations, especially those with major financial centers. Financial activities and risk exposures are increasingly globalized. A system without a common detailed taxonomy for securities and counterparties and comparable requirements for reporting across countries would make assembling a meaningful picture of the exposures of global institutions very difficult. Efforts to improve data collection are already under way in the European Union, by the Bank of England and the Financial Services Authority, and the European Central Bank, which has expressed support for developing a unified international system of taxonomy and reporting. The Financial Stability Board, at the request of the G-20, is initiating an international effort to develop a common reporting template and a process to share information on common exposures and linkages between systemically important global financial institutions.Barriers to Effective Data Collection for Analysis Legislation will be needed to improve the ability of regulatory agencies to collect the necessary data to support effective supervision and systemic risk monitoring. Restrictions designed to balance the costs and benefits of data collection and analysis have not kept pace with rapid changes in the financial system. The financial system is likely to continue to change rapidly, and both regulators and market participants need the capacity to keep pace. Regulators have been hampered by a lack of authority to collect and analyze information from unregulated entities. But the recent financial crisis illustrated that substantial risks from leverage and maturity transformation were outside of regulated financial firms. In addition, much of the Federal Reserve's collection of data is based on voluntary participation. For example, survey data on lending terms and standards at commercial banks, lending by finance companies, and transactions in the commercial paper market rely on the cooperation of the surveyed entities. Moreover, as we have suggested, the data collection authority of financial regulators over the firms they supervise should be expanded to encompass macroprudential considerations. The ability of regulators to collect information should similarly be expanded to include the ability to gather market data necessary for monitoring systemic risks. Doing so would better enable regulators to monitor and assess potential systemic risks arising directly from the firms or markets under their supervision or from the interaction of these firms or markets with other components of the financial system. The Paperwork Reduction Act also can at times impede timely and robust data collection. The act generally requires that public notice be provided, and approval of the Office of Management and Budget (OMB) be obtained, before any information requirement is applied to more than nine entities. Over the years, the act's requirement for OMB approval for information collection activity involving more than nine entities has discouraged agencies from undertaking many initiatives and can delay the collection of important information in a financial crisis. For example, even a series of informal meetings with more than nine entities designed to learn about emerging developments in markets may be subject to the requirements of the act. While the principle of minimizing the burdens imposed on private parties is an important one, the Congress should consider amending the act to allow the financial supervisory agencies to obtain the data necessary for financial stability in a timely manner when needed. One proposed action would be to increase the number of entities from which information can be collected without triggering the act; another would be to permit special data requests of the systemically important institutions could be conducted more quickly and flexibly. The global nature of capital markets seriously limits the extent to which one country acting alone can organize information on financial markets. Many large institutions have foreign subsidiaries that take financial positions in coordination with the parent. Accordingly, strong cooperative arrangements among domestic and foreign authorities, supported by an appropriate statutory framework, are needed to enable appropriate sharing of information among relevant authorities. Strong cooperation will not be a panacea, however, as legal and other restrictions on data sharing differ from one jurisdiction to the next, and it is unlikely that all such restrictions can be overcome. But cooperation and legislation to facilitate sharing with foreign authorities appears to be the best available strategy. Significant practical barriers also exist that can, at times, limit the quality of data collection and analysis available to support effective supervision and regulation, which include barriers to sharing data that arise from policies designed to protect privacy. For example, some private-sector databases and bank's loan books include firms' tax identification (ID) numbers as identifiers. Mapping those ID numbers into various characteristics, such as broad geographic location or taxable income measures, can be important for effective analysis and can be done in a way that does not threaten privacy. However, as a practical matter, a firm may have multiple ID numbers or they may have changed, but the Internal Revenue Service usually cannot share the information needed to validate a match between the firm and the ID number, even under arrangements designed to protect the confidentiality of the taxpayer information obtained. In addition, a significant amount of financial information is collected by private-sector vendors seeking to profit from the sale of data. These vendors have invested in expertise and in the quality of data in order to meet the needs of their customers, and the Federal Reserve is a purchaser of some of these data. However, vendors often place strong limitations on the sharing of such data with anyone, including among Federal agencies, and on the manner in which such data may be used. They also create systems with private identifiers for securities and firms or proprietary formats that do not make it easy to link with other systems. Surely it is important that voluntary contributors of data be able to protect their interests, and that the investments and intellectual property of firms be protected. But the net effect has been a noncompatible web of data that is much less useful, and much more expensive, to both the private and the public sector, than it might otherwise be. Protecting privacy and private-sector property rights clearly are important policy objectives; they are important considerations in the Federal Reserve's current data collection and safeguarding. Protecting the economy from systemic risk and promoting the safety and soundness of financial institutions also are important public objectives. The key issue is whether the current set of rules appropriately balances these interests. In light of the importance of the various interests involved, the Congress should consider initiating a process through which the parties of interest may exchange views and develop potential policy options for the Congress's consideration.Organization Structure for Data Collection and Developing Analytical Tools In addition to balancing the costs and benefits of enhanced data and analytical tools, the Congress must determine the appropriate organizational form for data collection and development of analytical tools. Budget costs, production efficiencies, and the costs of separating data collection and analysis from decisionmaking are important considerations. Any proposed form of organization should facilitate effective data sharing. It also should increase the availability of data, including aggregated supervisory data as appropriate, to market participants and experts so that they can serve the useful role of providing independent perspectives on risks in the financial system. The current arrangement, in which different agencies collect and analyze data, cooperating in cases where a consensus exists among them, can certainly be improved. The most desirable feature of collection and analysis under the existing setup is that it satisfies the principle that data collection and analysis should serve the end users, the regulatory agencies. Each of the existing agencies collects some data from entities it regulates or supervises, using its expertise to decide what to collect under its existing authorities and how to analyze it. Moreover, the agencies seek to achieve cost efficiencies and to reduce burdens on the private sector by cooperating in some data collection. An example is the Consolidated Reports of Condition and Income, or Call Reports, collected by the bank regulatory agencies from both national and state-chartered commercial banks. The content of the reporting forms is coordinated by the Federal Financial Institutions Examination Council, which includes representatives of both state and Federal bank regulatory agencies. A standalone independent data collection and analysis agency might be more nimble than the current setup because it would not have to reach consensus with other agencies. It might also have the advantage of fostering an overall assessment of financial data needs for all governmental purposes. However, there would also be some substantial disadvantages to running comprehensive financial data collection through a separate independent agency established for this purpose. A new agency would entail additional budget costs because the agency would likely need to replicate many of the activities of the regulatory agencies in order to determine what data are needed. More importantly, because it would not be involved directly in supervision or market monitoring, such an agency would be hampered in its ability to understand the types of information needed to effectively monitor systemic risks and conduct macroprudential supervision. Data collection and analysis are not done in a vacuum; an agency's duties will inevitably reflect the priorities, experience, and interests of the collecting entity. Even regular arms-length consultations among agencies might not be effective, because detailed appreciation of the regulatory context within which financial activities that generate data and risks is needed. The separation of data collection and regulation could also dilute accountability if supervisors did not have authority to shape the form and scope of reporting requirements by regulated entities in accordance with supervisory needs. An alternative organizational approach would be available if the Congress creates a council of financial regulators to monitor systemic risks and help coordinate responses to emerging threats, such as that contemplated in a number of legislative proposals. Under this approach, the supervisory and regulatory agencies would maintain most data collection and analysis, with some enhanced authority along the lines I have suggested. Coordination would be committed to the council, which could also have authority to establish information collection requirements beyond those conducted by its member agencies when necessary to monitor systemic risk. This approach might achieve the benefits of the current arrangement and the proposed independent agency, while avoiding their drawbacks. The council would be directed to seek to resolve conflicts among the agencies in a way that would preserve nimbleness, and it could recommend that an agency develop new types of data, but it would leave the details of data collection and analysis to the agencies that are closest to the relevant firms and markets. And while this council of financial supervisors could act independently if needed to collect information necessary to monitor the potential buildup of systemic risk, it would benefit directly from the knowledge and experience of the financial supervisors and regulators represented on the council. The council could also have access to the data collected by all its agencies and, depending on the staffing decisions, could either coordinate or conduct systemic risk analyses.Conclusion Let me close by thanking you once again for your attention to the important topic of ensuring the availability of the information necessary to monitor emergent systemic risks and establish effective macroprudential supervisory oversight. As you know, these tasks will not be easy. However, without a well-designed infrastructure of useful and timely data and improved analytical tools--which would be expected to continue to evolve over time--these tasks will only be more difficult. We look forward to continued discussion of these issues and to a development of a shared agenda for improving our information sources. I would be happy to answer any questions you might have. ______ CHRG-111hhrg48674--66 Mrs. Maloney," What gets me is we keep trying so many things, and what I am hearing from the public and what I hear from my colleagues in Congress is that the loans are not getting out to the public. Now, banks say that they are increasing their loans, but there is some type of disconnect. Maybe they are long-term loans that were made a long time ago. New credit is not getting out into the markets. We just came back from a retreat of the Democrats, and my colleagues were telling me across the country, in every State, they feel that their constituents are telling them they can't get access to credit. Very reasonable, respected businesses are having their long-term credit cut, and there is no credit for commercial loans. There seems to be a huge problem there, and I would like to hear your ideas. Obviously, the bank system is the wheel that has to get our economy going, yet we hear that part of the new program is there is going to be a business and consumer loan program coming from the Federal Reserve. Why is that coming from the Federal Reserve? Shouldn't that be coming from our financial institutions? Why can't we get them working properly? Is the problem the toxic assets? Do we need to get them off the books? I don't think we should have to create a new lending system. Why can't we get the lending system that has served this country for decades working? Why is credit not getting out there to the public, and what can we do about it? " CHRG-111shrg54789--189 RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM TRAVIS B. PLUNKETTQ.1. Both Mr. Yingling and Mr. Wallison testified repeatedly that the Administration's plan would result in credit being rationed to consumers, particularly consumers who need the credit the most. They also argued that the requirement that additional disclosures or warnings accompany products that are not ``plain-vanilla'' products would result in only those standard products being offered. Specifically, Mr. Wallison testified that `` . . . when a provider is confronted with the choice of whether to offer only the plain-vanilla product or the more complex product, he has to decide whether this particular consumer is going to be able to understand the product.'' Because lenders will be reluctant to make such judgments, they will, by default, offer the plain-vanilla product only, thereby constraining consumer choices. How do you respond to these arguments?A.1. Poor regulation of abusive credit products by Federal regulators over many years has led to exactly the result that Mr. Yingling and Mr. Wallison are concerned about: credit rationing. Deceptive and unsustainable lending practices by credit card companies and mortgage lenders led to record defaults and foreclosures by consumers, record losses by lenders, a crisis in the housing markets and the recession. These developments, in turn, have led to a ``credit crunch'' where credit card lenders, for example, have significantly reduced credit lines and sharply increase interest rates, even for borrowers with stellar credit scores. Had a Consumer Financial Protection Agency existed to prevent the excesses that occurred in the lending markets, there is a very good chance that this country could have avoided the worst aspects of the housing and economic crisis, and of the somewhat indiscriminate reduction in credit availability that has occurred. In other words, proper regulation will create the kind of stability in the credit markets that encourages lenders to offer credit to consumers, especially those who do not have perfect credit ratings. Similarly, the ``plain-vanilla'' requirement is designed to create choices in the credit marketplace that don't exist now, and certainly did not exist during the credit boom. ``Choices,'' such as prepayment penalties that lock consumers into unaffordable loans and ``exploding ARM'' loans that lenders knew many of their borrowers could not afford, crowded out less abusive options from the marketplace and ultimately harmed consumers and the economy. Lenders are quite capable of designing simple, understandable financial products that are profitable for them and useful for consumers, if they chose to do so." FOMC20070131meeting--346 344,MR. LACKER.," I thought the documentation distributed by the staff did a good job of identifying the purposes that publishing forecasts ought to serve. They’re consistent with what I described in past meetings as guiding principles—namely, that communication is useful to the extent that it helps the public form better expectations about future policy and inflation and that it will help in that regard to the extent that it provides benchmarks against which people can assess their future actions. For me the purposes of communicating a forecast are, first, to reduce uncertainty in the public’s mind about future macroeconomic outcomes; second, to enhance our credibility and accountability; third, to improve the coherence and internal consistency of our discussions. It’s useful to stack up different questions and approaches against these purposes and to see how they do. In any case—and this is a theme to which I will return—in achieving these objectives, I think it’s really important that published forecasts be clear and understandable to the public. Now, the cardinal rule of communication is to understand your audience. It’s one thing to explain our forecast and procedure to Larry Meyer or Goldman Sachs economists; it’s another to explain it to President Plosser’s $2 million business head, the Helena Rotary Club, or wherever we find ourselves from time to time. Before addressing Vince’s questions, I just want to note that I think the value of publishing a forecast would be greatest if it were paired with an internal agreement about our long-run objective for inflation. I think having a prior consensus on that would simplify the process of obtaining a consensus on the outlook and about policy. My own preference is that we state that publicly. To the extent that an inflation objective represents a commitment regarding future policy, you can view it as representing an implied forecast of the long-run average value of inflation, and so publicizing that would help reduce the public’s uncertainty along a very important dimension. Regarding Vince’s first question, I believe a single Committee forecast is most desirable. This relates to the accountability objective. We are jointly responsible for the outcomes of monetary policy, so I think we should strive for an outlook that we can fairly agree represents a collective sense of the Committee. The value of accountability is that it enhances credibility, and it’s the credibility of the Committee rather than of individual members that’s really important. I recognize that crafting a consensus on a forecast among nineteen or even twelve members, even as collegial a group as this is, could be a daunting task. One approach would be to allow the expression of dissenting views. This runs the risk, however, of making a Committee forecast nothing more than a compilation of members’ forecasts, and I think it needs to be more than that. The message that the release of a Committee forecast should convey is that we came to a process with diverse views, we talked things over, our views perhaps moved closer together, and we ultimately came to agreement on a single forecast that most of us saw as not too different from our own. That meaning would be watered down if there were a lot of dissenting views—if they were too frequent or too numerous. So I think there should be sort of a high threshold of disagreement before any of us insists on differences being separately articulated. I would envision a process—I think one of Vince’s options sketched this—in which the staff produces an initial forecast along the lines of the Greenbook (they have a great forecasting record) and members would send in their own forecasts, commentaries, or disagreements. Then there would be some iterative communication process on the basis of which a new forecast would be developed for a Committee vote. Regarding the question of conditioning assumptions, I strongly believe that what we publish should reflect our best sense of what is actually going to happen. My preference, accordingly, would be to condition forecasts on how we think we are actually going to set policy as events unfold. Conditioning on any other assumption—a market’s policy path or an unchanged policy— means having to explain that our forecast may be counterfactual. It means that, in order to figure out our real forecast, people have to figure out how our policy choices are going to differ from our assumed policy and then guess how we think the differences in policy are going to affect the forecast. It means that the extent to which our published forecast reduces the public’s uncertainty about future macroeconomic outcomes is going to be limited. It means that our accountability will be limited because we will be saying up front that this forecast might not be our actual one. It also means that we will be chewing up valuable staff and Committee time constructing a forecast we don’t necessarily believe in. Here I think it’s instructive to imagine explaining a counterfactual forecast to President Plosser’s $2 million business head or to the Helena Rotary Club. I realize that some members of the Committee may be uncomfortable articulating an expected path for the federal funds rate, but what we publish about the nature of future policy settings is a separate question from whether we condition on a cohesive view about them. Our discussion of the forecast is going to be much more coherent if we reach a consensus on future policy. Telling the public that our forecast assumes appropriate policy obviously makes more sense, I think, if we have stated what inflation rate that policy is designed to achieve. If, instead, we adopt some counterfactual policy assumption, then not stating an inflation objective makes a published forecast even less informative since people would have to know how the forecast differs from our desired outcomes before figuring out what to make of it. As for Vince’s other questions, on questions 3 and 4, I think the accompanying narrative should be handled pretty much the same way the minutes are—drafted by the staff and approved by the Committee. On questions 5 and 6, I see greater value in publishing forecasts at longer horizons. In the event that we adopt an explicit objective, we would want the period to be long enough to show the forecast path for inflation returning near to the objective. Again, if we condition it on market assumptions, the period needs to be long enough to determine whether the forecast appears to be moving toward our objective at an acceptable pace. Question 7 asks how many variables we should forecast. I think the optimal number is four. [Laughter] In case you want to know which ones I’d choose, I’d say real GDP, inflation, the unemployment rate, and the fed funds rate. On question 8, yes, we absolutely should convey the uncertainties surrounding the forecast. I think it’s important for accountability that we articulate our sense of the range of likely future outcomes. This points to the importance of not simply assuming a path for the fed funds rate but allowing policy to vary across different draws of the shocks that are going to affect our future economic conditions. Otherwise our published fan charts for economic variables are not going to correspond to the probability distribution that we believe will actually govern future outcomes, and again, we’ll have to explain the difference to the public. Also, I think that agreeing on a fan chart around outcomes is likely to be conducive to achieving a consensus within the Committee on the outlook. In closing, let me reiterate the importance that I place on clarity. Our communication goals of reducing the public’s uncertainty about macroeconomic outcomes, particularly inflation, and enhancing our accountability strongly imply that we should adopt only a procedure that we can easily explain to the public, that the public will find useful, and that avoids the confusion of complex and subtle counterfactual assumptions." CHRG-111shrg50815--79 Chairman Dodd," Thank you. One of my concerns about this, and we have had long discussions in the past about interchange fees, it is about a $48 billion revenue stream this year alone, the estimates are, just from interchange fees coming in. What it does, it creates the climate of sort of the liar loan problem we saw with the residential mortgage market because there, the idea is then the sheer volume of the number of cards out there create a revenue stream, just by the volume of the cards out. And the incentive then to determine whether or not the borrower actually is creditworthy reduces tremendously under this system. That is one of the concerns I have about it and one of the reasons we ought to have--again, I am not trying to deny someone the access to a credit card, but at least having some responsibility and some understanding of that, that when you have a revenue stream of $48 billion coming in, on the average, it is 2 percent, I think is the average interchange fee, more or less, coming in. That is a remarkable revenue stream and the disincentive to have some verification of the ability of the consumer to meet those obligations, and that contributes, I think, to that environment, which is important. Senator Tester? Senator Tester. Thank you, Mr. Chairman, and I think it is in order to congratulate you for having a daughter, a 3-year-old daughter that has effectively used a credit card very, very well. [Laughter.] Senator Tester. You know, there have been some comparisons here between using credit cards and buying sweaters, and I think it is OK to make those kind of comparisons, but very seldom when I go home back to Montana do I see three or four sweaters laying on the kitchen table for my kids. This is about--and my concern isn't about adults who know better. I am talking about folks who have been in the business world a bit or the workforce a bit. My concern is about credit card companies that put out an offer that is just too good to be true, and then once the fish is hooked, then the fees go up, people starting getting jerked around, and it is just totally not right. It is simply not right. There has been talk of several bills here today. I have got another one. I think just about every one of these can be incorporated, not to squash the credit card companies, but quite frankly, when I go home, and they don't know the earning history of any of my kids, and they have got a decent earning history now--and I hope they don't get credit cards because I said that--but the truth is that when they were in college, they didn't have much earnings history. When they were in high school, they certainly didn't have much of an earnings history. Then you go home and there are these credit cards laying there. So the question is this. It is for Mr. Clayton, because several times today during the testimony, you talked about these are significantly risky loans that are out there. If these really are significantly risky loans out there, why is there no requirement for any sort of earnings history whatsoever when you give a person a card, particularly a young person, but it could apply to anybody, and say, here it is. There is a line of credit for X-number of dollars. Go out and have fun. " CHRG-111hhrg48874--109 Mr. Long," The one thing I would add--and to agree with you in terms of where maybe creditworthy borrowers aren't getting credit--until we get that securitization market opened up, clearly credit is not flowing like it should. That is a huge problem that we have to get fixed. " CHRG-111hhrg53246--107 Mr. Sherman," Chairman Schapiro, I hope I have time to focus on the SEC's--what I would hope would be a policy, it is not your policy now--to surf the Internet, pose as an investor, and deal with all the unregistered activity. Because too much of the SEC's attitude seems to be, well, if they don't register with us, we don't focus on them. And that is especially necessary because we have relied on State regulation. But now with the Internet, it is easy to steal half a million dollars in each of 50 States; whereas in the past, if you were going to steal several million dollars, you had to do it pretty much in one area. But I want to use my time to focus on derivatives. Derivatives offer the potential to make huge fortunes to those who are very powerful. And so they are defended because there is the tiniest argument that they do some good some of the time. And I refer here to over-the-counter derivatives. Secretary Geithner reserved the right to use taxpayer funds to the full extent of the law not only to bail out old derivatives but to bail out derivatives that are issued tomorrow. So they operate with that subsidy, or implied subsidy, that maybe Treasury will figure out a way to bail out counterparties. The defense of derivatives is that on rare occasions they are actually purchased by someone who has a risk they are trying to hedge; and that on even rarer occasions, they can't hedge that risk efficiently on an exchange-traded derivative, so they need the over-the-counter derivative. I don't know if either of you have done any studies. But what percent of the over-the-counter derivatives are purchased by those who really are hedging a risk rather than the more common case of somebody just placing a casino bet? I mean, I could wake up today and think pork bellies are going up and place a bet, and I would love--those who like gambling would think that is a wonderful idea, but I don't own any pigs. I will ask either of you. Do either of you know what percentage of this multitrillion-dollar industry, conducted in part at the risk of the U.S. taxpayer, is serving its alleged legitimate, societal purposes? Ms. Schapiro. I think because this has been such an opaque market and it is such a broadly unregulated market, that it is very hard for regulators to actually-- " FOMC20080109confcall--44 42,MR. KOHN.," Thank you, Mr. Chairman. I certainly share your concern that the current federal funds rate is too high. You said that you thought we had about offset the effects of tighter credit and declining house prices on demand. I'm not so sure that we have actually done enough to make that offset. Certainly, if you look at the staff forecast, we haven't. They have the unemployment rate rising to 5� percent, half a point over the NAIRU, at the current funds rate, which suggests to me that the current funds rate is substantially above neutral, not at neutral. If you look at the market--and, President Fisher, I assure you I am not going to get pushed around by the market--I do think the market is telling you that there are a lot of people out there who think that the funds rate has to drop 100-plus basis points more, and they don't think that will be consistent with a pick up in inflation. Now, they could be wrong. I'm sure they probably are and often are. But I think there is some signal there about the degree of pessimism out there about underlying demand that we shouldn't throw away entirely just because it is coming from the market. So in my view, policy is probably still restrictive rather than neutral. I don't think we fully adjusted to the deteriorating condition we saw in December. What we saw then was that the credit constriction had spread and would be bigger and more prolonged than we had thought previously. We saw a steeper, more intense housing decline, with multiplier�accelerator effects, and wealth effects on the decline in house prices. We saw the beginning of spillovers to other sectors, and I don't think our 25 basis points really adjusted to all that new information. Moreover, the incoming information, although it hasn't lowered the near-term GDP, does imply weaker growth going forward. With regard to the labor market, it is true that it is one month, but it is three different sources of data--the household survey, the establishment survey, and the initial claims--all telling us the same thing. Now, we will get more information over the next couple of weeks on at least the initial claims part of that and the continuing claims. I think we should treat the labor market information as more than just one series for one month. It's three series for one month, and there is probably a little more weight there. In addition, the new orders and the ISM survey, housing, and stock market wealth have declined substantially since the meeting. So I would say, obviously, we have no insurance. I'm not even sure we're at neutral, and I see the downside risks that you, Mr. Chairman, Dave Stockton, and many others have talked about, particularly from the credit markets and credit conditions. I agree that the inflation situation is somewhat concerning. Now, some people have cited the increase in the staff's inflation forecast for 2008 of 0.4 percentage point; but of course that's the energy price situation. I think so far through this cycle the feed-through of energy prices into core inflation has been pretty darn low. The staff has built in a little here. Inflation expectations do remain anchored. To be sure, the core inflation numbers came in a little higher, so they're a little worrisome, too. I think there is going to be less pressure on resources than we thought. The unemployment rate is higher, capacity utilization will be lower, and I think the competitive pressures are going to constrain compensation and prices. As somebody pointed out, the fact that even at a 4� percent unemployment rate we really have seen very little, if any, pickup in labor costs suggests that my concern about that occurring at a 5 and a 5� percent unemployment rate would be very, very low. If the staff is right--and, of course I just heard the Romers lecture me about how the staff was right and the Committee wasn't--[laughter] then a 50 basis point decline would just about put interest rates at neutral. It wouldn't be accommodative, and therefore, I don't think would be particularly inflationary. I agree with everyone else. If I thought that a decline in rates would increase the most likely forecast for inflation--put it on an upward track--that would be unacceptable. Or if I thought a decrease in rates would increase inflation expectations, which would then give legs to an increase in inflation, that would not be acceptable either. But I think a decrease in rates at this time under these circumstances doesn't really have that risk. It does shift the balance of risks a bit. If you take a little of the downside risk out of growth, you are presumably taking some of the downside risk out of inflation, maybe shifting that risk on inflation at the same time. But I think a substantial decrease in interest rates at this time would not shift those risks on inflation so that they would deviate from the general path over the next couple of years that most of us saw in our projections in October. So I'm not as concerned as President Lacker about that. In sum, I agree that we need to reduce rates substantially just to get close to buying insurance. I would do it sooner rather than later. I would have been prepared to support an intermeeting move today. I think the data are weak enough; we are far enough behind the curve. To me, looking at the equity market declines, what we have seen since the middle of December is a bit of a loss in confidence in the financial markets that we will do enough soon enough to keep the economy on an even keel. So I think there has been a palpable deterioration in confidence in the Federal Reserve out in the financial markets. I am concerned that we are going to get three weeks of bad news and that the erosion of confidence will just gather steam. But I see the issues and the negatives also. An orderly FOMC process is to be protected. We are at risk of scaring the markets or looking as though we are lurching. I think we are at risk, if we move, of creating market dynamics such that they would constantly be in volatility and on alert as to when the next intermeeting move is. So there are a bunch of negatives here; and I guess on balance the case for moving--especially if it's not supported generally by the Committee because I think it has to be supported generally by the Committee--is not overwhelming. Obviously, I am prepared to wait and make a substantial move at the meeting, but I agree that you should signal something in your speech tomorrow that we are likely to move against the emerging economic weakness. I don't think, President Fisher, that a speech that the Chairman makes after consulting with the whole FOMC is comparable to the speeches we make as individuals. He doesn't have the risk of misleading the market when he has heard from all of us at the same time. This is a very different situation from the situation that many of us were in during the previous intermeeting period. Thank you, Mr. Chairman. " CHRG-111shrg50814--98 Mr. Bernanke," Senator, we have gone beyond interest rate policy to try to find new ways to ease credit markets, and I have talked about in some recent speeches and testimonies three general types of things we have done. The first is to make sure that there is plenty of liquidity available for banks and other financial institutions, not only in the United States, but around the world in dollars. So we have been lending to banks to make sure they have enough cash liquidity so they won't be afraid of loss of liquidity as they plan to make commitments on the credit side. Second, as I already indicated, we have been involved in purchasing GSE securities, which has brought down mortgage rates. The third group of activities encompasses a number of different programs which have been focused primarily on getting non-bank credit markets functioning again. We were involved, for example, in doing some backstop lending to try to stabilize the money market mutual funds and also to stabilize the commercial paper market, and we have had some success in bringing down commercial paper rates and commercial paper spreads and giving firms access to longer-term money than they were getting in September and October. Likewise, one of our biggest programs is just commencing now, which is an attempt to provide backstop support to the asset-backed securities market. That market is one where the financing for many of our most popular types of credit--auto loans, student loans, small business loans, credit card loans, all those things--have historically been financed through the asset-backed securities market. Those markets are largely shut down at this point. Through our TALF facility which is about to open, we, working with the Treasury, expect to get those markets going again and help provide new credit availability in those areas. So it is not just the banks. If we are going to get the credit system going again, we need to address the non-bank credit sources and we are aggressively looking at all the possible ways we can to do that. Senator Martinez. Speaking about the TALF and the credit facilities that have been opened, at some point, the concern shifts to what happens after a recovery begins to unfold in anticipation of perhaps in the latter part of this year, with some good fortune, and perhaps in the beginning of the next if not, that we will be in the recovery mode. At that point, how long will it take to phaseout those types of facilities like the TALF and what factors will determine the timing and the process by which you will do that? " CHRG-110hhrg46594--489 Mr. Sachs," Congressman, we are quite overwhelmed right now in our economy and management to be able to manage a very delicate operation with thousands of firms and suppliers and a catastrophic headline of a bankruptcy of one of these companies. My view is it would be an unbelievable gamble under normal times and unthinkable right now. So I just wouldn't go that way at all for this under the conditions of recession verging on collapse. We don't have the bandwidth right now to handle another crisis of that magnitude and to negotiate that. If in 6 months or 9 months the situation is spiraling downward, and the $25 billion was not enough, you are going to come to one of those. But this is not the time to come to it right now. " CHRG-111hhrg52406--201 Mr. Plunkett," Mr. Chairman, we responded to a request to consider if the notion to set up a consumer protection agency focused on a provision of credit and payment systems, to consider insurance in that light, and there are some positive aspects to that idea. In particular, what we threw out just before you arrived was the idea of a holistic jurisdiction from the consumer protection point of view over the entire credit transaction to include insurance products that are directly related to that credit transaction. Title, mortgage, credit, and forced placed insurance are some examples. To answer your previous question, credit insurance has been a major part of single premium credit insurance, in particular, abusive mortgage lending practices. It has been tied very closely. " FOMC20070918meeting--54 52,MR. MADIGAN.,"2 I will be referring to the table in the package labeled “Material for FOMC Briefing on September Trial-Run Projections.” I will first focus on the near term. The upper panel of the table shows the forecasts for the second half of the year that are implied by the estimates that you submitted for the first half of 2007 and your projections for the year as a whole. Participants revised down their expectations for real GDP growth in the second half of 2007 by several tenths of a percentage point. Most of you cited the steeper-than-expected downturn in housing markets and tighter credit conditions as key factors. The downward revision to output growth was accompanied by a slight upward revision to the unemployment rate. Your forecast for total inflation in the second half of this year was revised down noticeably, but the central tendency for core inflation was unrevised. Almost all of you conditioned your outlook on near-term monetary policy easing. A slight majority characterized the Greenbook’s assumption of a 50 basis point near-term reduction in the target funds rate as appropriate monetary policy, but almost as many think a somewhat larger cumulative decline will prove appropriate. The lower panel shows your annual forecasts. The central tendency for GDP growth in 2008 was revised down about ¼ percentage point and now centers on about 2¼ percent rather than 2½ percent. The central tendency for the unemployment rate at the end of the year revised up 0.2 percentage point. Your total inflation forecast for next year edged down 0.1 percentage point, but the central tendency of your core projections was unchanged. You also again characterized your views of uncertainty relative to historical norms and skews. Those views presumably apply primarily to the relatively near term outlook. Most of you again see risks to growth as tilted to the downside. In contrast, almost all of you now see inflation risks as roughly balanced rather than as tilted to the upside. A majority of you judge that the uncertainty attending the prospects for economic activity is greater than has been typical in the past. Looking further ahead, the projections for 2009 changed little. For the first time, you submitted forecasts for 2010. The forecasts for those years and your commentary suggest that most of you see actual and potential GDP growth over that period at around 2½ percent, a bit above the staff’s estimate. The unemployment rate hovers just below 5 percent. (Let me note at this point that in the table there is a typo in the 2009 column for the unemployment rate. The central tendency of August projections should read 4.7 to 5.0 percent.) With the unemployment rate just a bit above the 4¾ percent that a number of you have identified as your estimate of the NAIRU, both core inflation and total inflation are expected to edge lower in the out years—at least if you squint hard and focus particularly on the lower bound of the central tendencies. [Laughter] Your forecasts for core and total inflation in 2009 are essentially unrevised—not surprisingly, if you view those forecasts as reflecting to an important 2 Materials used by Mr. Madigan are appended to this transcript (appendix 2). degree your longer-run objectives. The relatively narrow central tendencies and ranges for total and core inflation in 2009 and 2010 suggest substantial agreement in your views on this score. That concludes our presentation." CHRG-110hhrg46596--36 Mrs. Maloney," Thank you, Mr. Chairman, for having this hearing. Regrettably, the report from GAO today makes clear that Treasury is not taking responsibility for making sure that the moneys are used consistently with the purposes of the Act. We will have to legislate that we want accountability, transparency, a systemic system with regulators so that we can track and find out where this money is going. A prime purpose of this Congress was to help people stay in their homes. I completely support FDIC Commissioner Sheila Bair's program, and am willing to legislate it with my colleagues. But we urge Treasury to put it in place. We do not know what banks are doing with their money because Treasury will not tell us. But the press tells us that they are buying highways in Europe, that they are buying other banks, or that they are holding on to the money. What my constituents tell me is they cannot have access to capital. We have put $7.8 trillion of taxpayers' money out there for the purpose of creating credit, and it has been a dismal failure. The car dealers were in my office yesterday from New York State. Americans want to buy their cars in New York State, but they cannot get credit from banks. What I am getting calls on is the proposed 4.5 percent interest rate to get new homes in the pipeline and get our economy moving. We need to get credit out in our communities in order to revive our economy. Economist after economist has told us we will not solve this crisis until we solve the problem of keeping people in their homes and getting the housing market moving again. I look forward to your proposal on the 4.5 percent interest rate--my phone has been ringing off the hook in support of it--or any ideas or programs you have to get credit out into our economy to get our economy moving again. Thank you. " FinancialCrisisInquiry--62 In the consumer area—and there are other people here who have consumer businesses— clearly, all that’s been written about origination and Jamie referred to stated income without tests, and I’m sure he can pick up that cudgel and talk about on the consumer side. On the more corporate side, I would say it had to do with leverage and it had to do with terms, covenants, conditions. The markets got more competitive. There was a sense that the world had a lot of liquidity. And so the commodity of money got less scarce and people paid less attention to it. BLANKFEIN: And as a consequence, people were lending to support transactions, which is a business that we’re very familiar with, that had more multiples of debt for the equity and the conditions that applied—the covenants, the maintenance, the things that allowed a lender to intervene in the company became more and more lax, and so you could intervene less. So that lack of rigor on the—on the transactional side I think had its counterpart in the consumer side and in the commercial lending side, which others here are more familiar with. HOLTZ-EAKIN: Were you aware of this at the time? Did you see the standards going down? And if so, how did you highlight this in your risk management? BLANKFEIN: In all honesty, we did—we did know. You cannot miss the fact that the covenants are getting a little lighter and that the leverage is getting bigger. With the benefit of hindsight, I wish I weren’t in the position of having to explain it. But at the time, I know we all rationalized the way a lot of people—other people—have rationalized. “Gosh, the world is getting wealthier. Technology has done things. Things are more efficient. Interest—there’s no inflation. Things belong low. These businesses are going to do well.” And I think we talked—much of the world did—talked yourself into a—into a place of complacency, which we should not have gotten ourselves into and which, of course, after these events, will not happen again in my lifetime, as far as I’m concerned. CHRG-111hhrg51592--27 Mr. Dobilas," Thank you for the opportunity to participate in this hearing. The rating agency legislation passed by Congress in 2006 was an important step forward. It greatly improved the regulatory process by which a rating agency can receive a national designation from the SEC, and it has in fact increased the number of competitors. But given the worldwide collapse of the credit markets, and the loss of trillions of dollars by individuals, companies, and governmental entities, it is now clear that Congress needs to take further action addressing the conflicts of interest which have arisen in the context of having rating agencies paid by the corporations whose debt they are evaluating. As the Congressional Oversight Panel has stated, the major credit rating agencies played an important and perhaps decisive role in enabling and validating much of the behavior and decisionmaking that now appears to have put the broader financial statements at risk. Realpoint uses a different business model than S&P, Moody's, and Fitch. We are an independent, investor-paid business, which means our revenues come from investors, portfolio managers, analysts, broker dealers, and other market participants who typically buy a subscription to our services. We produce in-depth monthly rating reports on all current commercial mortgage-backed securities. Moody's, S&P, and Fitch, on the other hand, are paid by the issuers of the securities. They are paid substantial upfront fees on a pre-sale basis by the corporations selling securities or investment banks which are underwriting the sales. The fees can exceed $1 million in a single transaction. In a word, the results of the issuer-paid business model have been miserable. The SEC recently published data showing that Moody's has had to downgrade 94.2 percent of all the subprime residential mortgage-backed securities it rated in 2006. This is the equivalent of a major league baseball player striking out 19 out of 20 times at bat. We see a similar trend developing now in the CMBS market. In contrast, Realpoint's ratings were lower from the outset, and have proven to be more stable than those of the issuer-paid agencies. Even during these unprecedented times, downgrades at Realpoint are less than 30 percent on all current CMBS transactions, and have generally taken place 6 to 12 months sooner than the corresponding rating actions taken by other rating agencies. The core problem with the issuer-paid system, and the most important message I would like to leave with the subcommittee today, is that the integrity of the rating process is undermined by the pervasive practice of rating shopping. When an issuer decides to bring a new security to market, it generally begins the process by providing data to the three rating agencies. The three rating agencies are more than willing to provide preliminary levels on ratings, knowing that the issuer will tend to hire the agencies that provide the highest ratings. We hear a lot about complexities of modern finance, but the rating process is hardly complex. The solution is equally simple, and it only takes one step. Let all the designated rating companies have the same information and prepare their own pre-sell ratings, regardless of whether or not they are ultimately paid by issuers or by investors. In our view, there is simply no better or more straightforward way to enhance the integrity of the ratings process than to share the information with all agencies which the SEC has deemed as worthy of being a nationally recognized agency. In fact, the SEC has already proposed precisely such a rule, through an amendment to its fair disclosure rules. The public benefits of taking this simple step are immediate and manifestly obvious. Last year, the Federal Reserve began implementing the Term Asset-Backed Securities Loan Facility, or TALF Program. Initially, the ratings component of TALF was limited to Moody's, S&P and Fitch. We are pleased to learn that the Federal Reserve is now taking steps to increase the number of rating agencies eligible to participate in this program. As a matter of fact, we just learned that Realpoint and DBRS are now part of the TALF program. We believe that this will increase competition and lead to more accurate ratings behind the taxpayer guarantees which stand behind these programs. TALF and other comparable programs utilize the standard industry practice of requiring two ratings in order for securities to be deemed suitable collateral. There is likewise no valid public policy reason for not insisting that at least one of these ratings be an independent investor-based rating. In this manner, the TALF program serves not only as a catalyst for restarting the securitization market, but as a vanguard to reform the credit rating industry. A mandate to have TALF and other government assisted programs utilize the ratings of at least one independent rating agency would enhance investor confidence in those programs and set the stage for ultimately resurrecting reliable ratings in the private sector. In short, the American taxpayers should not be subject to the same failed rating shopping syndrome I described earlier. In conclusion, the integrity of the ratings process is deeply flawed, but this is not a complex problem, and, in fact, it is not that different from when we were all in high school and everyone sought out the teachers who were known as easy graders. We simply need to put an end to the rating shopping process that encourages issuer-paid rating agencies to inflate their ratings. Thank you very much for your time. [The prepared statement of Mr. Dobilas can be found on page 58 of the appendix.] " FOMC20080625meeting--19 17,MR. DUDLEY.," I think there is some stigma attached to the Primary Dealer Credit Facility. It is hard to know exactly how much. One thing I thought was interesting: The first week the facility was outstanding, a number of institutions went to the Primary Dealer Credit Facility and then announced that they were doing it as a test. Now, presumably you wouldn't announce that you were doing it as a test if there were no stigma associated with the facility. But I would judge that it is clearly less stigmatized than the Primary Credit Facility, probably because it doesn't have the history that the Primary Credit Facility has. The fact is that it is an advantageous rate or was an advantageous rate several weeks ago, and there were some institutions that were borrowing from the facility just on the basis of rate--so that suggests less stigma than the discount window. " CHRG-110shrg46629--29 Chairman Bernanke," Well, it is going down because the credit losses associated with subprime have come to light and they are fairly significant. Some estimates are on the order of between $50 billion and $100 billion of losses associated with subprime credit products. The credit rating agencies have begun to try to make sure they account for those losses and they have downgraded some of these products. I should say that the investors, many of them, recognize even before the downgrades occurred that there were risks associated with these products including not only credit risks but also liquidity and interest rate and other types of risks. And so the spreads they were charging on these products were not necessarily the same as would be implied by the credit rating agency. Senator, if I could just say one word about Basel, I would be very grateful. It is simply not the case that Basel II is about lowering credit standards. It is about making the banking system safer, not less safe. Senator Shelby. I did not say credit standards. We are about capital. " CHRG-111shrg50564--20 Chairman Dodd," Well, I would welcome that as you give it more thought. Last, let me address the issue of systemic risk regulation again. And I realize I am not specifically referring to the report in some cases. I am drawing upon your knowledge and expertise in these areas. The G-30 report describes one of the lessons from the current crisis as follows, and let me quote it. It says: Unanticipated and unsustainably large losses in proprietary trading, heavy exposure to structured credit products and credit default swaps, and sponsorship of hedge funds have placed at risk the viability of the entire enterprise and its ability to meet its responsibilities to its clients, counterparties, and investors. Three questions: Should we allow financial institutions to become large and systemically significant? Should there be a single systemic risk regulator or should that substantial be shared among different agencies? Should the systemic risk responsibility be given to the Federal Reserve, in your view? And are you concerned that it would also be a burden on the Federal Reserve with numerous divergent tasks which you and I have discussed? And I will not elaborate here. You know the point I am trying to make. And, third, are you concerned that extensive involvement by the Fed in so many aspects of day-to-day operations of the economy and the financial system might jeopardize its independence? " CHRG-111shrg57320--244 Mr. Carter," I think that we did tell them. Senator Levin. No, you said you cannot just simply tell them, ``You made a commitment and haven't kept it.'' Why can't you say those words? Like ``unacceptable,'' why can't you use the word ``unacceptable'' in your documents? We were finally able to get you to say that here today, but your documents--that is not the way you talk. Why can't you tell someone you regulate, ``Folks, you made a commitment 6 months ago, and it was conditioned''--``our determination that you could become part of WaMu was dependent on you making that commitment. You haven't kept it?'' Why can't you look people in the eye and say, ``You made a commitment. You haven't kept it?'' " CHRG-110shrg50410--145 CHRISTOPHER COX At an April 3, 2008 hearing, you told me that if market manipulation or insider trading played a role in the rapid demise of Bear Stearns, ``The rumors surrounding the activity you described are too big to miss, and our Enforcement Division is very active for a number of reasons.'' While I understand that this is a law enforcement issue, I hope this matter will be resolved promptly.Q.1. Would you care to update the Committee on any proceedings the SEC is undertaking in this situation?A.1. On July 13, the Commission announced that the SEC and other securities regulators are conducting sweep examinations aimed at the prevention of the intentional spreading of false information intended to manipulate securities prices. The examinations are being conducted by the SEC's Office of Compliance Inspections and Examinations, as well as the Financial Industry Regulatory Authority, Inc. and New York Stock Exchange Regulation, Inc. The sweeps include both broker-dealers and hedge fund advisers. And on April 24, the Commission brought its first-ever case of securities fraud and market manipulation for intentionally spreading false rumors.Q.2. With your recent actions to limit certain types of short selling on major financial firms, do you believe that types of short selling may have played a role in distorting the market over the past few weeks? Did it possibly play a role in the demise of Bear Stearns leading up to its March 2008 merger with JP Morgan Chase?A.2. The Commission's staff is currently preparing a detailed analysis of the events surrounding the distressed sale of Bear Stearns to JPMorgan Chase. That analysis is looking at the full range offactors including the role played by market rumors, novations in the over-the-counter derivatives markets, short sales, and general conditions in the credit markets. That study has not yet reached any conclusions." fcic_final_report_full--286 In March, the Office of Thrift Supervision, the federal regulator in charge of regu- lating AIG and its subsidiaries, downgraded the company’s composite rating from a , signifying that AIG was “fundamentally sound,” to a , indicating moderate to se- vere supervisory concern. The OTS still judged the threat to overall viability as re- mote.  It did not schedule a follow-up review of the company’s financial condition for another six months. By then, it would be too late. FEDERAL RESERVE: “THE DISCOUNT WINDOW WASN ’ T WORKING ” Over the course of the fall, the announcements by Citigroup, Merrill, and others made it clear that financial institutions were going to take serious losses from their exposures to the mortgage market. Stocks of financial firms fell sharply; by the end of November, the S&P Financials Index had lost more than  for the year. Between July and November, asset-backed commercial paper declined about , which meant that those assets had to be sold or funded by other means. Investment banks and other financial institutions faced tighter funding markets and increasing cash pressures. As a result, the Federal Reserve decided that its interest rate cuts and other measures since August had not been sufficient to provide liquidity and stability to fi- nancial markets. The Fed’s discount window hadn’t attracted much bank borrowing because of the stigma attached to it. “The problem with the discount window is that people don’t like to use it because they view it as a risk that they will be viewed as weak,” William Dudley, then head of the capital markets group at the New York Fed and currently its president, told the FCIC.  Banks and thrifts preferred to draw on other sources of liquidity; in particular, during the second half of , the Federal Home Loan Banks—which are govern- ment-sponsored entities that lend to banks and thrifts, accepting mortgages as collat- eral—boosted their lending by  billion to  billion (a  increase) when the securitization market froze. Between the end of March and the end of December , Washington Mutual, the largest thrift, increased its borrowing from the Federal Home Loan Banks from  billion to  billion; Countrywide increased its bor- rowing from  billion to  billion; Bank of America increased its borrowing from  billion to  billion. The Federal Home Loan Banks could thus be seen as the lender of next to last resort for commercial banks and thrifts—the Fed being the last resort.  In addition, the loss of liquidity in the financial sector was making it more diffi- cult for businesses and consumers to get credit, raising the Fed’s concerns. From July to October, the percentage of loan officers reporting tightening standards on prime mortgages increased from  to about . Over that time, the percentage of loan officers reporting tightening standards on loans to large and midsize companies in- creased from  to , its highest level since .  “The Federal Reserve pursued a whole slew of nonconventional policies . . . very creative measures when the dis- count window wasn’t working as hoped,” Frederic Mishkin, a Fed governor from  to , told the FCIC. “These actions were very aggressive, [and] they were ex- tremely controversial.”  The first of these measures, announced on December , was the creation of the Term Auction Facility (TAF). The idea was to reduce the dis- count window stigma by making the money available to all banks at once through a regular auction. The program had some success, with banks borrowing  billion by the end of the year. Over time, the Fed would continue to tweak the TAF auctions, of- fering more credit and longer maturities. CHRG-111hhrg58044--375 Chairman Gutierrez," I thank you. Ms. Kilroy, you are recognized for 5 minutes. Ms. Kilroy. Thank you, Mr. Chairman. Thank you to the panelists. Ms. Fortney, you stated that you believed that medical debt is predictive in determining an individual's credit worth? Ms. Fortney. I believe I said medical debt collection information. It is my understanding that is the information that is used in credit scoring, as witnesses testified at the last hearing. Ms. Kilroy. Witnesses when they testified at the last hearing--I ask unanimous consent to enter into the record a May 3rd letter from VantageScore to me. You believe it is appropriate that we consider medical debt differently depending on where the information is coming from? Is that what you are telling us? Ms. Fortney. No. What I am saying is in credit scoring systems, as I recall, I think it was the witness from Fair Isaac that testified, in a credit scoring system, the credit scoring models they have developed, they used collection information including medical debt collection information in the development of those models because that information has been found to be predictive in the models that are predicting credit risk. Ms. Kilroy. You disagree with VantageScore which stated categorically that, ``We do not believe medical debt will contribute to predictive performance?'' Ms. Fortney. I have not seen that letter. I would like to see it before I comment on it. Ms. Kilroy. Would you agree or disagree with the statement? Ms. Fortney. What is that statement again? Ms. Kilroy. Do you agree or disagree that medical debt will contribute to predictive performance? Ms. Fortney. What I understand and what I have said is we are talking about collection information. That statement refers to medical debt alone without discussing whether that medical debt information is limited to collection information. Ms. Kilroy. Mr. Rukavina, you talked about the confusion and inconsistency in medical debt reporting. You have taken a look, as I understand, at some medical debt studies. Have you seen when taking a look at or talking to either lenders or others an impact that medical debt, including paid medical debt, may have on a person's ability to obtain, say, a home loan? " CHRG-111shrg55739--157 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BENNETT FROM MARK FROEBAQ.1. As we move forward on strengthening the regulation of credit rating agencies, it is important that we do not take any action to weaken pleading and liability standards of the Private Securities Litigation Reform Act of 1995. This Committee worked long and hard, and in a completely bipartisan fashion, to craft litigation that would help prevent abusive ``strike'' suits by trial lawyers. These suits benefited no one but the lawyers who orchestrated these suits. This was a real problem then, and could become a real problem again if we dilute the current standard that applies to all market participants. Perpetrators of securities fraud, and those who act recklessly, can be sued under the law we passed in 1995. Is there any justification for now altering this standard just for credit rating agencies?A.1. Yes, there is ample justification for altering the pleading and liability standards just for the credit rating agencies. Here are three arguments in support of changing these standards. First, the major rating agencies have enjoyed the privilege of a Government-sponsored monopoly for many years. In order to reduce the negative consequences of this monopoly, the Government also encouraged competition among the agencies. There is overwhelming circumstantial evidence that the agencies responded by competing with each other not on price or efficiency or productivity or quality but, instead, on rating standards, revising rating methodologies and standards whenever necessary to build or maintain market share and revenue. Changing pleading and liability standards for the agencies would provide a key restraint should rating standards ever again end up in competitive free fall. Fear of liability will curb the appetite for market share, dampen the negative effects of competition, improve rating quality and, thereby, ultimately make lawsuits less necessary. The rating agencies, in exchange for continuing to enjoy the privilege of a Government-sponsored monopoly, should be subjected to easier pleading and liability standards at least where litigants claim that bad ratings have injured them. Second, when the rating agencies generate bad credit opinions, they have nothing at risk except their reputations. Other market participants involved in the transactions that failed in the subprime crisis, e.g., investment banks, investors, and collateral managers, all had some financial stake in these transactions. When these participants got it wrong, they were punished by financial losses, in some cases even to the point of bankruptcy. Having a significant financial risk is enough to warrant separate pleading and liability standards for these market participants. If reputation risk alone once provided the rating agencies with the same kind of incentives as financial risk, Enron taught them a new lesson. The bankruptcy of Enron within only days of losing its investment-grade ratings did severe damage to the reputation of the agencies but did little to hurt their business. In the aftermath of Enron, the rating agencies enjoyed some of their most profitable years ever. Thus, fear of reputation damage after Enron did nothing to check the ratings that caused the subprime crisis. It would be very difficult now to overstate the damage that the subprime crisis has done to the reputation of the rating agencies. If they all survive the current crisis unscathed--as seems almost certain--they will be taught a lesson very dangerous to world financial system: no matter how bad their ratings, no matter how damaged their reputations, they will not fail and the rating business will not go away because there is nowhere else for it to go. Without incentives that are far more potent than reputation risk, we cannot expect the rating agencies to reform themselves and impose greater quality and accuracy on their ratings. Third, the rating agencies have long enjoyed near complete immunity from liability for bad ratings. This immunity is based upon an old line of cases that found the rating business--assigning and reporting ratings--to be a form of journalism subject to free speech protections. More than 40 years ago, this finding had some merit. The rating agencies assigned ratings to bonds and then reported all of their ratings in periodicals sold to subscriber/investors. Bond issuers paid the rating agencies nothing. However, the rating agencies largely abandoned this model 40 years ago. The new model shifts the cost of the rating from subscriber/investors (eager for the most accurate rating) to bond issuers (eager for the highest rating). It is easy to see how the new model changed the rating agencies' incentives. It is also difficult to imagine how real journalism could make a similar business-model switch. (It would be as if each newspaper story were commissioned by the subject of the story, based solely upon facts submitted by the subject, and published only upon the subject's approval of the story and payment of a fee for its writing and publication.) Eventually, the courts will discover that the credit rating business is no longer anything like a form of journalism and should not be entitled to free speech protections. This will not happen overnight and may be a long and expensive process. In the meantime, the financial markets need help restoring their confidence in the quality and integrity of credit ratings assigned today. Changing the pleading and liability standards just for the agencies is an important first step in this process.Q.2. Will the threat of class action litigation, and the costs of endless discovery, be at cross-purpose with the goal of fostering greater competition in credit rating markets?A.2. No. Some of the newly formed rating agencies are adopting an investor-pay business model. These new agencies will enjoy the same free speech protections that have so far shielded the major rating agencies from litigation. If investor-pay rating agencies continue to enjoy this protection while issuer-pay agencies lose it, the result will be a very strong incentive for new agencies to adopt the investor pay model. Second, even now the rating business enjoys very high profit margins. Unlike other businesses with such high profit margins, the rating business has virtually no costs for research and development or advertising. Even if current profit margins were cut in half by litigation costs, they would remain very attractive compared to other businesses and a strong enticement to the creation of new rating agencies. If the risk of litigation materially improves rating quality and integrity (and thereby prevents another ratings driven financial crisis like the second subprime crisis), this benefit will far outweigh whatever costs litigation imposes.Q.3. Would this potential create a disproportionate burden for smaller players in the industry?A.3. No. Small players will not be attractive targets for harassment litigation not only because they do not have the ``deep pockets'' attractive to such litigation but also because they have no history of bad ratings. They will only be at risk of such litigation during the next Enron or subprime crises. In a normal rating environment, it often takes years for a transaction to go bad and for ratings to appear wrong. New agencies should not face a litigation burden for quite some time. In the meantime, the biggest burden for smaller players in the industry will be lack of demand for their ratings. Unless Government policy vigorously encourages the use of ratings from new rating agencies, the new agencies may never survive long enough to suffer the litigation burden implied by this question.Q.4. Do you believe that the threat of harassment litigation could act as a barrier to entry to those considering entry into the rating agency business?A.4. No. The threat of harassment litigation will do two things. First, as noted above, it will create a strong incentive for new agencies to adopt the investor-pay model. Under this model, rating agencies should continue to enjoy significant free speech protection against liability for ratings and considerable immunity from litigation. Thus, the potential for harassment litigation could have the positive effect of inducing more new agencies to adopt the issue-pay model. Second, litigation targeting the rating agencies will be related to bad ratings assigned in the past. New agencies will not be subject to such litigation. Thus, in theory they will have a competitive advantage over existing rating agencies which must incorporate the cost of this litigation into their rating fees. Additional Material Supplied for the Record Hearings Before the Committee on Banking, Housing, and Urban Affairs (January-August 2009) Date Hearing TitleJanuary 13................... Nomination of Shaun DonovanJanuary 15................... Nominations of Mary Schapiro, Christina D. Romer, Austan D. Goolsbee, Cecilia E. Rouse, and Daniel K. TarulloJanuary 27................... The Madoff Investment Securities Fraud: Regulatory and Oversight Concerns and the Need for ReformFebruary 4................... Modernizing the U.S. Financial Regulatory SystemFebruary 5................... Pulling Back the TARP: Oversight of the Financial Rescue ProgramFebruary 10.................. Oversight of the Financial Rescue Program: A New Plan for the TARPFebruary 12.................. Modernizing Consumer Protection in the Financial Regulatory System: Strengthening Credit Card ProtectionsFebruary 24.................. Federal Reserve's First Monetary Policy Report for 2009February 26.................. Homeowner Affordability and Stability PlanMarch 3...................... Consumer Protections in Financial Services: Past Problems, Future SolutionsMarch 5...................... American International Group: Examining What Went Wrong, Government Intervention, and Implications for Future RegulationMarch 10..................... Enhancing Investor Protection and the Regulation of Securities Markets--Part IMarch 12..................... Sustainable Transportation Solutions: Investing in Transit To Meet 21st Century ChallengesMarch 17..................... Perspectives on Modernizing Insurance RegulationMarch 18..................... Lessons Learned in Risk Management Oversight at Federal Financial RegulatorsMarch 19..................... Modernizing Bank Supervision and Regulation--Part IMarch 19..................... Current Issues in Deposit InsuranceMarch 24..................... Modernizing Bank Supervision and Regulation--Part IIMarch 26..................... Enhancing Investor Protection and the Regulation of Securities Markets--Part IIMarch 31..................... Lessons From the New DealApril 16..................... A 21st Century Transportation System: Reducing Gridlock, Tackling Climate Change, and Growing Connecticut's EconomyApril 23..................... Nominations of Ronald Sims, Fred P. Hochberg, Helen R. Kanovsky, David H. Stevens, Peter Kovar, John D. Trasvina, and David S. CohenMay 6........................ Regulating and Resolving Institutions Considered ``Too Big To Fail''May 7........................ Strengthening the SEC's Vital Enforcement ResponsibilitiesMay 13....................... Manufacturing and the Credit CrisisMay 13....................... Nominations of Peter M. Rogoff, Francisco J. Sanchez, Raphael W. Bostic, Sandra Henriquez, Mercedes Marquez, and Michael S. BarrMay 20....................... Oversight of the Troubled Assets Relief ProgramJune 3....................... A Fresh Start for New StartsJune 4....................... Nomination of Herbert M. Allison, Jr.June 10...................... The State of the Domestic Automobile Industry: Impact of Federal AssistanceJune 16...................... Greener Communities, Greater Opportunities: New Ideas for Sustainable Development and Economic GrowthJune 18...................... The Administration's Proposal To Modernize the Financial Regulatory SystemJune 22...................... Over-the-Counter Derivatives: Modernizing Oversight To Increase Transparency and Reduce RisksJuly 7....................... Public Transportation: A Core Climate SolutionJuly 8....................... The Effects of the Economic Crisis on Community Banks and Credit Unions in Rural CommunitiesJuly 14...................... Creating a Consumer Financial Protection Agency: A Cornerstone of America's New Economic FoundationJuly 15...................... Regulating Hedge Funds and Other Private Investment PoolsJuly 16...................... Preserving Homeownership: Progress Needed To Prevent ForeclosuresJuly 17...................... The U.S. as Global Competitor: What Are the Elements of a National Manufacturing Strategy?July 22...................... Federal Reserve's Second Monetary Policy Report for 2009July 22...................... Nomination of Deborah MatzJuly 23...................... Establishing a Framework for Systemic Risk RegulationJuly 28...................... Regulatory Modernization: Perspectives on InsuranceJuly 29...................... Protecting Shareholders and Enhancing Public Confidence by Improving Corporate GovernanceJuly 30...................... Minimizing Potential Threats From Iran: Assessing Economic Sanctions and Other U.S. Policy OptionsAugust 4..................... Strengthening and Streamlining Prudential Bank Supervision--Part IAugust 4..................... Rail Modernization: Getting Transit Funding Back on TrackAugust 5..................... Examining Proposals To Enhance the Regulation of Credit Rating Agencies " FOMC20081216meeting--76 74,MR. HOENIG.," All right. Thank you, Mr. Chairman. I would like to start off also by saying how much I appreciate this. I think it is an important opportunity for us not necessarily to agree--because committees are designed to bring different views together and, one hopes, to come to consensus--but to hear one another and to feel more comfortable knowing where we are as we move from here. So I really do appreciate this opportunity. I am going to go through the questions in somewhat the order they were given, and let me begin by discussing the first two questions on policy strategy. The key issues here are how low to move the fed funds rate target and at what speed. I agree with the view that keeping your powder dry is no argument for not going immediately to zero. However, I think that there are other good reasons for not going to zero at this time. In fact, the condition of the financial markets is a strong argument for being especially cautious at this juncture about going toward zero and about how fast if we were to choose to do that. It is clear from the studies, at least the way I read the studies that were provided--which I would also add were just excellent--that the market dysfunction in some very important markets, including the Treasury market, increases substantially as you move toward the zero bound. At what precise level this occurs is not defined, but evidence does suggest that it is a genuine issue. Indeed, markets are clearly showing signs of impairment in that the effective federal funds rate is trading well below the current target of 100 basis points. It would be unfortunate if our monetary policy actions were to cause major and avoidable effects on the functioning of these markets, especially with the current fragile state of the financial system and when the benefits, as I interpret them, are not obviously significant. I believe we can minimize the damage, so to speak, in these markets by maintaining the fed funds target above 50 basis points--I prefer 100--and by taking actions to ensure that the effective funds rate trades closer to the target over time, recognizing where we are starting from. The way to do this, of course, is to put limits on the size of the current swaps and liquidity programs--I suppose that is, as others have said, a size limit on the balance sheet--to the point that the Desk can begin to sterilize the reserve injections of these other programs. We are not there, I realize, but I would like to see that as the goal. Turning to question 3 on communication strategies, there is evidence that communications about the future policy path may have measurable effects on interest rates and other asset prices, especially in circumstances where the markets and the central bank have different views about the future policy path that need to be reconciled. Especially in the United States, a statement about the policy path is likely to be more influential on market expectations than a statement on inflation right now. As to the statement about the policy path, it is possible to have a significant effect on longer-term rates when market views about the policy path differ significantly from our views and there is credible commitment to keep the target rate low for a very long period of time. In general, I think that it is difficult to construct a very specific statement that is credible to markets and does not unduly tie the hands of this Committee. Consequently, if the Committee decides to adopt language about future policy actions, I would prefer more-general rather than more-specific condition statements. I would note that the moregeneral language we used in '03 through '05 appears to have been more effective than the Bank of Japan's more-specific conditioning statements during the period of quantitative easing. As to the inflation communications, I would be opposed to a statement that suggests that inflation risks have threatened the dual mandate and that the Committee will act to mitigate this risk. I also expect inflation to come down over the next few months, but this reflects considerable unwinding of temporary factors, as we noted elsewhere, and the risk of deflation is modest at this time. I also would be strongly opposed to a statement that suggests that we would accept higher-than-normal inflation rates in the next few years. While such a statement might be appropriate in a deflationary environment, the U.S. economy is not yet at that point. Instead, our inflation rate has been higher than acceptable for the past five years, I believe in part because of our willingness--understandably, but still our willingness--to err on the side of accommodation. In the future, should inflation come in very low for a sustained period of time, such a statement about accepting higher inflation might have some benefit in preventing a sharp decline in inflationary expectations. But in today's circumstances, such a statement could lead markets again to conclude that we would respond very slowly to higher inflation pressure in the future. I think it would confuse and not actually clarify. On nonstandard policy tools, I am okay with expanding the purchase of agency debt and mortgage-backed securities and longer-term Treasuries. Right now, all, in my view, are government guaranteed. However, I am not in favor of direct support of private securities through backstop credit facilities or other procedures. I am of the view that we have stepped far in the direction of credit allocation and have undertaken actions that are fiscal measures and not appropriate for a central bank, even in a crisis like this. In my opinion, the long-run costs to the economy and the Federal Reserve of engaging in credit allocation exceed the near-term benefits of supporting limited segments of the market. There is a relative price effect. In terms of agency and Treasury purchases, I agree that the immediate focus should be on reducing the agency spreads over comparable Treasuries. Treasury rates have come down a good deal, but agency spreads have widened. Normally, private yields move with the Treasury rates, as we know. However, the current crisis has largely broken the usual connection. Therefore, I don't think that actions to lower Treasury rates further will have much effect on other rates, and I would concentrate more on bringing other rates down. However, in the coming months, as the economy begins to recover, Treasury rates will likely come under upward pressure. To the extent that markets begin to incorporate a view of the policy path that differs from ours, I think we might want to consider purchases, as discussed here, of longer-term Treasuries at that time or perhaps altering our communication strategy then. On the form of the directives, I would generally favor quantitative targets for Desk purchases. Although it will be somewhat difficult for this Committee to determine appropriate quantitative targets, I don't think we want to move in the direction of specifying targets for interest rates or spreads for these other instruments because the exit strategy for these approaches could be very disruptive for the financial markets. In terms of communicating our use of nonstandard tools, if we go that way, I think that the more we say, the better for everyone. It is important to articulate the range of options under discussion; and when they are announced, it is important to discuss not only how they will be implemented but also how they would be expected to help in achieving our objectives. Right now confidence is quite fragile, as we all know, and so it is important that we send positive and constructive messages and not unduly surprise the markets with our actions. Two other issues not directly related: As we talk about our policies going forward, I think we really do need to spend a little more time talking about what it means in terms of the deleveraging process that is going on. People talk about it freely, but I don't think it is clear in anyone's mind and would perhaps affect our actions. Also we need to talk about the potential effects of the fiscal policies that will be unveiled soon. Thank you very much. " CHRG-111shrg50814--140 Mr. Bernanke," Well, before now, there were legal issues about what the appropriate priority was, who was primarily responsible, and so on, and what I am saying is that I think that what we have learned from this episode is that the holding company supervisor must have some ability, in conjunction with the functional regulator, to look at the condition and behavior of the firms below the holding company level, and that is something I have started doing and we intend to do. In terms of the new holding companies that have come in, we have been very assiduous in making sure they have adequate capital, that they have restricted themselves to the activities which are appropriate for holding companies, so they are not involving in all kinds of other commercial activities, and we believe we are able to deal with those companies. But more generally, we are revisiting and rethinking our whole holding company supervision approach to make sure that we have a really comprehensive enterprise-wide approach that looks at all the risk factors, not just at the holding company level but also throughout the organization. " FOMC20080310confcall--41 39,MR. DUDLEY.," We are proposing the rough size of the facility today. As we gain experience with the facility and examine market conditions, we will be keeping the FOMC apprised of the programs and certainly seeking the input of the Committee on how to take this going forward. I hope that we will get a lot of feedback as we go through this auction process. If the bidding is very strong and if the markets are under tremendous distress, then we would probably want to increase the size of the program. Conversely, if the bidding is weak and if the markets settle down, then we would want to wrap up this program pretty quickly. " CHRG-110shrg50420--57 Mr. Dodaro," That is exactly right, Senator. Congress would establish the membership of the board, the authorities of the board, and Congress can establish whatever conditions it believes necessary to protect the taxpayers' interest to guide the board's decisions from a policy standpoint, including executive compensation, payment of dividends, et cetera. Senator Reed. And the other issue here is one of time because what we have heard the companies say is that they are in a very precarious cash-flow position, and that this board, one, to be established; two, to make a careful review probably with independent assistance is not something that can be done in a matter of days. " CHRG-111shrg52619--36 Mr. Reynolds," Chairman Dodd, I appear today on behalf of NASCUS, the professional association of State Credit Union Regulators. My comments focus solely on the credit union regulatory structure and four distinct principles vital to the future growth and safety and soundness of State chartered credit unions. NASCUS believes regulatory reform must preserve charter choice and dual chartering, preserve the States' role in financial regulation, modernize the capital system for credit unions, and maintain strong consumer protections. First, preserving charter choice is crucial to any regulatory reform proposal. Charter choice is maintained by an active system of federalism that allows for clear communications and coordination between State and Federal regulators. Congress must continue to recognize and affirm the distinct roles played by State and Federal regulatory agencies. The Nation's regulatory structure must enable State credit union regulators to retain their regulatory authority over State-chartered credit unions. Further, it is important that new polices do not squelch the innovation and enhanced regulatory structure provided by the dual chartering system. The second principle I will highlight is preserving the State's role in financial regulation. The dual chartering system is predicated on the rights of States to authorize varying powers for their credit unions. NASCUS supports State authority to empower credit unions to engage in activities under State-specific rules. States should continue to have the authority to create and to maintain appropriate credit union powers in any new regulatory reform structure. Preemption of State laws and the push for more uniform regulatory systems will negatively impact our Nation's financial services industry and ultimately consumers. The third principle is the need to modernize the capital system of credit unions. We encourage Congress to include capital reform as part of the regulatory modernization process. State credit union regulators are committed to protecting credit union safety and soundness. Allowing credit unions to access supplemental capital would protect the credit union system and provide a tool for regulators if a credit union faces declining network or liquidity needs. Further, it will provide an additional layer of protection to the National Credit Union Share Insurance Fund, the NCUSIF, thereby maintaining credit unions' independence from the Federal Government and taxpayers. A simple fix to the definition of ``net worth'' in the Federal Credit Union Act would authorize regulators the discretion, when appropriate, to allow credit unions to use supplemental capital. The final principle I will discuss is the valuable role States play in consumer protection. Many consumer protection programs were designed by State legislators and State regulators to protect citizens in their States. The success of State programs have been recognized at the Federal level when like programs have been introduced. It is crucial that State legislatures have the primary role to enact consumer protection statutes for their residents and to promulgate and enforce State regulations. I would also mention that both State and Federal credit unions have access to the NCUSIF. federally insured credit unions capitalize this fund by depositing 1 percent of their shares into the fund. This concept is unique to credit unions and it minimizes exposure to the taxpayers. Any modernized regulatory system should recognize the NCUSIF. NASCUS and others are concerned about any proposal to consolidate regulators and eliminate State and Federal credit union charters. As Congress examines a regulatory reform system for credit unions, the following should be considered. Enhancing consumer choice provides a stronger financial regulatory system. Therefore, charter choice and dual chartering must be preserved. Preservation of the State's role in financial regulation is vital. Modernization of the capital system for credit unions is critical for safety and soundness. And strong consumer protection should be maintained, and these should be protected against Federal preemption. NASCUS appreciates the opportunity to testify and share our priorities. We urge the Committee to be watchful of Federal preemption and to remember the importance of dual chartering and charter choice in regulatory modernization. Thank you. " FinancialCrisisReport--49 Financial Crisis Timeline 104 December 2006: Ownit Mortgage Solutions bankruptcy February 27, 2007: Freddie Mac announces it will no longer buy the most risky subprime mortgages March 7, 2007: FDIC issues cease and desist order against Fremont for unsafe and unsound banking April 2, 2007: New Century bankruptcy June 17, 2007: Two Bear Stearns subprime hedge funds collapse July 10 and 12, 2007: Credit rating agencies issue first mass ratings downgrades of hundreds of RMBS and CDO securities August 6, 2007: American Home Mortgage bankruptcy August 17, 2007: Federal Reserve: “[M]arket conditions have deteriorated … downside risks to growth have increased appreciably.” August 31, 2007: Ameriquest Mortgage ceases operations December 12, 2007: Federal Reserve establishes Term Auction Facility to provide bank funding January 2008: ABX Index stops issuing new subprime indices January 11, 2008: Countrywide announces sale to Bank of America January 30, 2008: S&P downgrades or places on credit watch over 8,000 RMBS and CDO securities March 24, 2008: Federal Reserve Bank of New York forms Maiden Lane I to help JPMorgan Chase acquire Bear Stearns May 29, 2008: Bear Stearns shareholders approve sale July 11, 2008: IndyMac Bank fails and is seized by FDIC July 15, 2008: SEC restricts naked short selling of some financial stocks September 7, 2008: U.S. takes control of Fannie Mae and Freddie Mac September 15, 2008: Lehman Brothers bankruptcy September 15, 2008 Merrill Lynch announces its sale to Bank of America September 16, 2008: Federal Reserve offers $85 billion credit line to AIG; Reserve Primary Money Fund NAV falls below $1 September 21, 2008: Goldman Sachs and Morgan Stanley convert to bank holding companies September 25, 2008: WaMu fails, is seized by FDIC, and is sold to JPMorgan Chase October 3, 2008: Congress and President Bush establish TARP October 12, 2008: Wachovia is sold to Wells Fargo October 28, 2008: U.S. uses TARP to buy $125 billion in preferred stock at nine banks November 25, 2008: Federal Reserve buys Fannie and Freddie assets 104 Many of these events are based upon a timeline prepared by the Federal Reserve Bank of St. Louis, “The Financial Crisis: A Timeline of Events and Policy Actions,” http://timeline.stlouisfed.org/index.cfm?p=timeline. fcic_final_report_full--318 In response to these losses, the Office of Thrift Supervision, WaMu’s regulator, re- quested that the thrift address concerns about asset quality, earnings, and liquidity— issues that the OTS had raised in the past but that had not been reflected in supervisory ratings. “It has been hard for us to justify doing much more than con- stantly nagging (okay, ‘chastising’) through ROE [Reports of Examination] and meet- ings, since they have not really been adversely impacted in terms of losses,”  the OTS’s lead examiner at the company had commented in a  email. Indeed, the nontradi- tional mortgage portfolio had been performing very well through  and . But with WaMu now taking losses, the OTS determined on February , , that its condition required a downgrade in its rating from a  to a , or “less than sat- isfactory.”  In March, the OTS advised that WaMu undertake “strategic initiatives”— that is, either find a buyer or raise new capital. In April, WaMu secured a  billion investment from a consortium led by the Texas Pacific Group, a private equity firm.  But bad news continued for thrifts. On July , the OTS closed IndyMac Bank in Pasadena, California, making that company the largest-ever thrift to fail. On July , , WaMu reported a . billion loss in the second quarter. WaMu’s depositors withdrew  billion over the next two weeks.  And the Federal Home Loan Bank of San Francisco—which, as noted, had historically served with the other  Federal Home Loan Banks as an important source of funds for WaMu and others—began to limit WaMu’s borrowing capacity. The OTS issued more downgrades in various as- sessment categories, while maintaining the overall rating at . As the insurer of many of WaMu’s deposits, the FDIC had a stake in WaMu’s condition, and it was not as generous as the OTS in its assessment. It had already dropped WaMu’s rating significantly in March , indicating a “high level of concern.”  The FDIC expressly disagreed with the OTS’s decision to maintain the  overall rating, recommending a  instead.  Ordinarily,  would have triggered a formal en- forcement action, but none was forthcoming. In an August  interview, William Isaac, who was chairman of the FDIC from  until , noted that the OTS and FDIC had competing interests. OTS, as primary regulator, “tends to want to see if they can rehabilitate the bank and doesn’t want to act precipitously as a rule.” On the other hand, “The FDIC’s job is to handle the failures, and it—generally speaking— would rather be tougher . . . on the theory that the sooner the problems are resolved, the less expensive the cleanup will be.”  FDIC Chairman Sheila Bair underscored this tension, telling the FCIC that “our examiners, much earlier, were very concerned about the underwriting quality of WaMu’s mortgage portfolio, and we were actively opposed by the OTS in terms of go- ing in and letting our [FDIC] examiners do loan-level analysis.”  FOMC20080318meeting--86 84,MR. KOHN.," Thank you Mr. Chairman. I agree with the others around the table who have said that the prospects for economic activity have taken another sizable leg down over the intermeeting period. I think we have been, for a time, in that adverse feedback loop between financial markets and spending that everybody--Governor Mishkin and others--has been talking about. That is not an unusual kind of loop to be in during a soft economic period. I think it is probably characteristic of a lot of slow growth and recessionary periods. But certainly it has been more intense this time because the financial turmoil has spread well beyond housing and has intensified significantly over the intermeeting period. The incoming data on spending, employment, and production were weaker than expected. House prices are moving lower by more than we or the markets expected. All of these data have accentuated concerns about the creditworthiness of households and businesses and, hence, about the creditworthiness of the people who lend to them, especially those who lend in the mortgage market. As perceptions of risk and risk aversion rose, there was a flight to safety and liquidity. I think we see that a little in the growth of M2 over the past couple of months, which has been very, very strong and suggests that households are retreating to money market funds, probably the ones that hold government securities, and to insured deposits. In wholesale markets there has been unwillingness to take positions and rising concerns about an array of intermediaries. Bill described this process much better than I could--illiquid markets, extreme volatility, deleveraging, margin calls, forced sales, especially in mortgage-backed securities, wider spreads, equity prices falling, and lending and funding tenors collapsing toward the overnight, again. So financial conditions have tightened for everybody but the government--and some of the European governments have seen them tighten, I guess. Mortgage rates have risen, and business bond yields have risen as well, even with Treasury rates going down. Tighter credit and declining equity and house prices are reducing wealth, and all of this weakens spending further. Now, to this process, the staff has judged that the economy has entered a recessionary state in which we can expect household and business spending to fall short of normal levels, given income and interest rates. I am not sure how much weight to put on this. I am a bit uncomfortable with constructs that don't have a clear story behind them. But I must say that, looking at the sentiment indicators and listening to what I have heard around the table today from almost every Federal Reserve District reporting, I now put more credence in Dave's recessionary state than I did before the meeting started. Obviously, something is going on that is undermining confidence and making people much more cautious than you would think, given the exogenous variables. I do think talking about the recessionary state underlines the extraordinary uncertainty we are dealing with. President Stern pointed out the 1990-91 precedent. There are some precedents for some aspects of this, but we don't have many; and I think it is really difficult to know how financial markets will evolve and how that will feed through to the variables that affect household and business spending--the reaction of households, businesses, and state and local governments to tighter credit conditions. I agree with President Stern, President Evans, and others who said they thought that the financial stresses are deeper and will last longer than we thought and will, therefore, put more restraint on spending. Until markets stabilize on a sustained basis, the risk to satisfactory economic performance by the U.S. economy will remain skewed very much to the downside. Now, Federal Reserve liquidity tools that we have used are necessary to reduce the odds on even more-intense, downward-spiral crises and market liquidity feeding back onto spending. So I think our innovations here have been useful to reduce the downside risks a little and thereby to promote spending. But I agree with the others who say that they don't directly deal with the underlying macro risk, which is really a story about capital, solvency, wealth, and prices. I think monetary policy easing is a necessary aspect of addressing these macroeconomic risks. I agree with President Fisher, President Plosser, and others that there is more going on and that monetary policy easing may not be a sufficient way of addressing these risks. But I do think, as long as the economy is weakening the way it is and we have these risks, that easing monetary policy will be helpful. It will help bolster asset prices. It will make the cost of capital lower than it otherwise would be. It may not be sufficient to turn the thing around, but I do think that without the easing that we have done-- and that I hope that we do today--the situation would be far worse than it otherwise would be. We need to ease to compensate for the substantial headwinds that we are facing. Now, the forecast for inflation has not been marked down despite the greater output gap. As others have remarked, this output gap is offset, to a considerable extent, by the upward pressure on prices from oil and commodities and import prices as the dollar has fallen and prices have risen in our exporting partners--China, for example. I have to confess that I don't really understand what has been happening to commodity prices in recent months. I don't think the rise has been justified by the news on the underlying conditions of supply and demand. It is much larger than the dollar weakness has been, and the dollar�commodity price has always been a weak relationship. So, in fact, commodity prices are rising in a bunch of currencies. This isn't just a dollar weakness problem. I have to believe that there is a speculative element here. Partly as a consequence, I am comfortable with the forecast of a flattening commodity price picture in the future--it might even decline, but at least a flattening out. I do think a shift from financial assets, especially dollar assets, into commodities is going on, and mostly this has been triggered by concerns about the U.S. economy and financial markets. In some sense, that shift is okay. It is driving down the dollar, and that is helping to stabilize the economy. The decline that we saw in oil prices yesterday suggests that, when people get more confidence about where those financial markets are going, some of those commodity prices will actually fall as the concerns about the U.S. economy are alleviated. It is sort of an upside-down relationship, but I do think we saw a bit of it that way. But I also sense that some of the rise in commodity prices and the fall in the dollar reflects concerns about the inflation outlook here. It is not surprising to me, in a very volatile and uncertain environment, that inflation expectations are not as well anchored and that they fluctuate a lot in response to new information. I expect that inflation will come down as commodity prices level off; then the output gap will increase, and that in turn will keep inflation expectations down. Still, navigating this appreciably weaker economic outlook for the real economy and the threats to financial stability, on the one hand, and the tenderness of inflation expectations, on the other, will require some discussion in the next section of our meeting, Mr. Chairman. " CHRG-109shrg30354--129 RESPONSE TO A WRITTEN QUESTION OF SENATOR REED FROM BEN S. BERNANKEQ.1. Chairman Bernanke, in your testimony you state that the standardized approach is ``essentially the same as the existing approach'' in Basel I. My understanding is that the standardized approach has some significant differences, including, for example, greater differentiation of assets by credit quality; an operational risk charge; more accurate measures of counterparty exposure; recognition of some credit risk mitigation measures; and risk-weighting of mortgages. Could you clarify for the record whether you really believe that the standardized approach is the same as Basel I?A.1. I believe that the general broad-brush approach to risk-weight categories and the expectations for risk management contained in the credit risk standardized approach in Basel II are not a large change from our existing Basel I-based capital rules. To be sure, there are a number of differences between Basel I and the credit risk standardized approach in Basel II, and your question highlights many of these differences. However, my remarks were made in the context of whether the Basel II credit risk standardized approach would be appropriate for large, internationally active banking organizations in the United States. In my opinion, the Basel II credit risk standardized approach is much less risk-sensitive than the Basel II advanced approach and does not make use of the most advanced risk management practices. For example, I note that the Basel II credit risk standardized approach generally provides the same risk weight for all first-lien mortgage loans (35 percent), nonmortgage retail loans (75 percent), and unrated corporate credits (100 percent), regardless of the creditworthiness of the borrower. As you are aware, the agencies intend to update the Basel I-based capital rules for most banks in the United States. In updating those rules, we expect to utilize some of the improvements in the Basel II standardized approach. CHRG-109hhrg31539--167 Mr. Bernanke," Well, Congressman, the Federal Reserve has testified on this issue. We have broadly two concerns from a public policy point of view. The first is the mixing of banking and commerce, which occurs when ILC banks are acquired by commercial firms. The Congress, through Gramm-Leach-Bliley, has indicated that it wants to keep banking and commerce separate, and I think this is inconsistent with that general approach. The second concern we have is that the FDIC is only given authority to supervise the ILC banks themselves, but not to do consolidated supervision of the parents. And we feel that safe and sound regulation and supervision requires consolidated supervision that takes into account the financial condition of the parent as well as the ILC itself. " FOMC20071031meeting--70 68,MR. POOLE.," Thank you, Mr. Chairman. I want to concentrate on the outlook for the nonhousing part. I think the housing sector is obviously in miserable condition, and the issue as to where that’s going to go really depends on how much of it spreads to other parts of the economy. Now, I have a contact with a large software firm, and the headline there is that things are going great—in fact, going gangbusters, I would say. Computer hardware sales nationally are running at 14 to 16 percent above last year, about 3 percentage points above expectation. Business IT growth is around 12 percent. Export sales are good. Server business is good. Computer gaming software is strong. Just overall a very bullish outlook there. Capital expenditures at this company are up about 35 percent this fiscal year over last fiscal year and are expected to be up another 15 percent in fiscal 2009. So the outlook is uniformly very, very strong. The company says it is behind in hiring and has lots of unfilled positions partly as a consequence of turnover. Now, all the other contacts were pretty downbeat. UPS is expecting a peak season that is milder than in the previous years; my contact believes that the economy is not going into a negative but is clearly slowing down. The company is leasing eleven fewer aircraft this year. To meet the peak, they always lease extra planes for shipping. They are probably holding about steady on capital outlays. My contact at FedEx says that the outlook is very soft, not much buildup toward the holiday peak. The retailers that they talked to are anticipating a softer season, not an absolute decline, but slow growth. International business remains very strong. This company is reducing capital expenditures by 10 percent from its previous expectation. My contact in a major company in the trucking industry says that we are in a recession, the worst he has seen in twenty to forty years. The company is reducing its fleet size by 10 percent, is cutting capital spending quite substantially, and has no good news. A contact with a major money center bank said that the bank’s analysis of credit card usage indicates that sales have been flat in some areas and are declining in others. Credit card usage for department store and catalogue sales has been declining. In an e-mail I received after that conversation, my contact painted a weaker picture than had been discussed the previous day. I think that there are other comments around the table suggesting that the anecdotal reports are a bit on the weak side. Now, to me there is a puzzle in the market’s assessment of the outcome of this meeting. The market has essentially bid in a probability of 1.0 of either a 25 or a 50 basis point cut. If I were simply following the flow of news, the general flow of news putting housing aside has been okay, maybe a little stronger than expected, and following this fed funds futures market for a long time, it does respond to the current information. The flow of data clearly moves that market, and if that were all that were driving the market, I guess I would have anticipated a 50-50 split between no change in the fed funds target and down 25 basis points. So why has the market bid in such a high probability of a cut at this time? I’ll offer a hypothesis, which is that a number of people who are players in this market, like my contact at a large bank, are looking at news and saying that the proprietary inside information they have on what’s going on leads them to believe that the overall economy has a soft tone to it that is not yet showing up in the data that we follow. I’m throwing out that hypothesis. I don’t know what other hypothesis to offer, but it does seem to be a reasonable one. Thank you." FOMC20081216meeting--3 1,MR. DUDLEY.,"1 Thank you, Mr. Chairman. Unfortunately this package is a little thicker than usual, but that's the way it goes, I guess. The stimulus provided by monetary policy to the real economy depends not only on the level of the federal funds rate but also on the health of the financial system. The ability of market participants to intermediate and act effectively as the transmission channel between the change in the federal funds rate target and financial asset prices is critical. When bank and dealer balance sheets are constrained as they are now, this transmission mechanism is impaired, and traditional monetary policy instruments become limited in their ability to support economic activity. 1 The materials used by Mr. Dudley are attached to this transcript (appendix 1). The recent sharp deterioration in the macroeconomic outlook and the forced deleveraging of the nonbank portion of the financial sector have led to sharp declines in asset values during the past few months. The consequence will be further big mark-to-market losses for investment and commercial bank trading books and a significant increase in loan-loss provisions on commercial bank loan books. These losses are likely to intensify the vise on financial firm balance sheets, and that is likely to further impede the Federal Reserve's efforts to ease financial conditions. As a consequence, a broadening of our suite of liquidity facilities that bypass banks and dealers may prove to be necessary. Equities, corporate debt, and securitized assets--especially commercialmortgage-backed securities (CMBS)--have all been hard hit, and the commodity sector, the preferred asset class of choice earlier in the year, has been clobbered. As shown in exhibit 1 of the handout, U.S. equity prices fell sharply beginning in September. Although the aggregate indexes have bounced off their low points, the S&P 500 index had still fallen 30 percent between the end of August and the end of November. This is the relevant quarter for Goldman Sachs and Morgan Stanley, which report this week. In the current calendar quarter, despite the rebound, the S&P 500 index has declined about 25 percent. The carnage has also been evident abroad, especially in emerging markets. The corporate debt market has scarcely been more hospitable. The high-yield corporate bond yield for some broad indexes has climbed above 20 percent (exhibit 2). Assuming a 20 percent recovery rate on defaults, yield levels in this sector appear to fully discount a default experience consistent with the peak reached in the Great Depression. The securitization markets have performed little better. Not only are most securitized markets shut to new issuance, but also the yields on even the highest-rated outstanding tranches have climbed sharply. Exhibit 3 illustrates the current spreads for different types of AAA-rated consumer securitizations--credit cards, auto loans, and student loans. Exhibit 4 illustrates the sharp deterioration in valuations in the CMBS market. The left panel shows spreads on a basket of post-2003 vintages. The right panel shows the price performance of particular AAA-rated CMBS tranches. Most have fallen about 20 points in the past quarter. Commodity prices also continue to plummet. As shown in exhibit 5, the declines have been particularly pronounced in the energy and industrial metals sectors. In contrast, gold prices have held up quite well (exhibit 6), especially since the October FOMC meeting. Gold prices presumably have been supported by the drop in global short-term interest rates, which reduces the carrying cost of owning gold. It is also possible that gold is viewed as a hedge against the risk that central bank policy actions could ultimately prove inflationary. Presumably, the fear may be that the exit from these policies could be delayed or prove more difficult to engineer than generally anticipated. This poor performance of financial and real assets has a number of important implications. In particular, the earnings of most major financial intermediaries will be very poor this quarter. For example, the two investment banks that report this week are almost certainly likely to record large mark-to-market losses. The Wall Street Journal reported earlier that Goldman Sachs will report a loss of around $2 billion when it reports tomorrow morning. This may actually understate the carnage because compensation booked for previous quarters can be reversed and the reversal of income taxes paid will reduce the size of the loss. Commercial banks will also not be spared when they report next month. Not only will they have significant losses on their trading books, but also loan-loss provisions are likely to climb sharply. JPMorgan indicated last week that the current quarter has been terrible, and they have been one of the best-performing commercial banks. The sharp decline in asset prices is also likely to reinforce the deleveraging process that is occurring throughout the financial sector. Although hedge fund performance in November was better than in the previous months, preliminary figures show that the aggregate index continues to slide (exhibit 7). We're down about 17 or 18 percent so far this year, and that's the worst performance in hedge fund history in the aggregate by a significant margin. Although the redemption deadlines for yearend have generally passed, this pressure will persist into the first quarter and beyond for two reasons. First, many fund-of-funds managers will get another round of redemption requests before year-end, which will cause them to ask for monies from the hedge funds that are part of their fund-of-funds families in the first quarter. Second, some hedge funds restrict or ""gate"" the rate of withdrawals. For example, Citadel suspended all redemptions for their two biggest funds through March 31. This means that there will be a backlog in unfulfilled requests that will take time to satisfy. The Bernard Madoff scandal may also lead to additional redemption requests. The losses suffered by dealers and banks mean that their balance sheet constraints will continue to stymie the Federal Reserve's efforts to supply liquidity to prospective borrowers. As shown in exhibit 8, recent TAF auctions have been undersubscribed, and as shown in exhibit 9, the amount of dollar liquidity supplied via our swap lines has stabilized even though term LIBOR remains elevated well above the minimum bid rate that we charge on those auctions and the fact that swaps are open-ended in size. The problem is no longer one of supplying sufficient liquidity to the banks and dealers. The problem is getting these intermediaries to pass the liquidity onward to their clients. Balance sheet constraints reveal themselves in many guises. Although LIBOROIS spreads have narrowed somewhat, they remain very elevated relative to historical levels (exhibits 10 and 11); jumbo mortgage rate spreads remain wide relative to conforming mortgage rates (exhibit 12); and cash instruments that take balance sheet room trade at significantly higher spreads than the corresponding derivatives that don't. Exhibit 13 illustrates the spread between high-yield cash bonds and the corresponding CDX high-yield derivatives index. This widening in that basis is one reason that some banks have taken large losses in the fourth quarter. Evidence that balance sheet constraints are impeding the availability and cost of credit continues to proliferate. This is obviously important because, if credit is not available on reasonable terms, this is likely to exacerbate the downward pressure on the economy. A darker economic outlook, in turn, threatens to lead to more losses and balance sheet pressures, reinforcing the downward dynamic. In terms of credit availability, the commercial mortgage area appears to be particularly vulnerable. According to industry sources, about $400 billion of mortgage debt--most put on five to seven years ago--needs to be refinanced when it comes due in 2009. In recent years, commercial banks and the CMBS market provided the major source of funds for the commercial mortgage market. The owners of this commercial real estate are worried that, without new Federal Reserve and Treasury initiatives, funding will not be available to refinance this mortgage debt in 2009 on virtually any terms. Investment-grade and high-yield corporate debt will also have to be refinanced. Exhibit 14 illustrates that more than $600 billion of term investment-grade corporate debt will need to be refinanced in 2009. So far, this market still looks open for business, but it may become less so if the macroeconomic environment continues to deteriorate. Enough gloomy news. In the credit markets, are there any areas that have shown improvement? The answer, of course, is ""yes."" In those areas in which the federal government, including the Federal Reserve, has applied the most force, the situation has generally stabilized or improved. Let me briefly give a few examples. First, the FDIC funding guarantee, the Citigroup intervention, and the $250 billion of TARP money allocated for bank capital seem to have stabilized the banking sector. As shown in exhibits 15 and 16, CDS spreads have been pretty stable recently despite the deterioration in the macroeconomic outlook. Second, the commercial paper funding facility (CPFF) has led to significant improvement in the commercial paper market. As shown in exhibit 17, the yields on highly rated commercial paper have declined. As this has occurred, the CPFF has become less attractive, and the number of issuers and the amount of commercial paper purchased each day by the CPFF have moderated sharply (exhibit 18). Just as important, after an initial surge in which the CPFF represented virtually all of the long-dated maturity issuance, the CPFF share of long-dated issuance has fallen significantly (exhibit 19). So far, the CPFF has worked pretty much as designed. Third, our announcement and purchases of agency debt have brought in agency debt spreads relative to Treasuries. For example, in the five-year sector, debt spreads for Fannie Mae and Freddie Mac have narrowed more than 50 basis points since the last FOMC meeting. Fourth, our announcement that the Federal Reserve would purchase up to $500 billion in GSE mortgage-backed securities has caused the spread between conforming mortgages and Treasuries to narrow sharply. Coupled with the fall in Treasury yields--encouraged somewhat by the Chairman's suggestion in a speech that the Federal Reserve might buy long-dated Treasuries for the SOMA--this has caused conforming mortgage rates to drop sharply (exhibits 20, 21, and 22). As a result, mortgage refinancing activity has climbed sharply. Exhibit 23 illustrates the spike upward in the Mortgage Bankers Association mortgage applications to refinance index that has occurred in the past two weeks. Exhibits 24 and 25 contrast the performance in markets with federal government intervention to those markets without. Spreads have generally narrowed where there has been intervention and widened elsewhere. The contrast in the behavior of spreads suggests that one might wish to expand our existing facilities further. The TALF is an obvious potential candidate given that it could conceivably be extended in multiple dimensions--including the scope of asset classes, vintage, and credit quality. In my opinion, the liquidity facilities should be viewed as part of our suite of monetary policy tools. The impulse of monetary policy to the real economy depends not just on the level of the federal funds rate but, more important, also on the impact on financial conditions. In normal times, movements in the federal funds rate result in moves in financial conditions in the same direction. Markets do the work, and financial conditions ease as the federal funds rate is cut. But in extraordinary times such as the present, in which banks and dealers are unwilling to on-lend liquidity because of balance sheet constraints, federal funds rate reductions alone may be ineffective in easing financial conditions. In such an environment, special liquidity facilities that bypass the banks and dealers may prove necessary to ease financial conditions. However, expansion of our liquidity tools does blow up our balance sheet. Exhibit 26 shows the growth of the balance sheet and the changes in its composition over time. Since late September, the balance sheet has grown sharply mainly because of the expansion of our foreign-exchange swap program (shown in light blue), the CPFF (shown in brown), and the TAF program (shown in purple). As shown in exhibit 27, which is a snapshot of our balance sheet late last week, this has caused excess reserves to rise sharply. The growth in excess reserves has been exacerbated by the rolling off of the Treasury SFP (supplementary finance program) bills. We peaked at about $500 billion earlier, and now we have $364 billion of SFP bills on our balance sheet. The Treasury was unwilling to continue this program at its earlier level because of worries about reaching the debt limit ceiling in the first quarter and because they would have had to notify the Congress 60 days before that. Turning now to the Desk's efforts to implement monetary policy and the FOMC's directive, the effective federal funds rate has continued to trade soft relative to the target rate (exhibit 28). The interest rate paid on excess reserves (IOER rate) has not been a perfect substitute for the Treasury SFP program. Because the IOER rate for the two-week reserve maintenance period is set at the lowest level that occurred anytime during that period, the sharp drop last Thursday evident in the exhibit occurred because banks anticipate a substantial cut in the federal funds rate target and the IOER rate at this FOMC meeting. The drop in the effective rate has occurred even though we have increased the rate paid on excess reserves to equal the federal funds rate target. Although some of this softness in the effective rate relative to the target reflects the sales of federal funds by GSEs that are not eligible to be paid interest on excess reserves, this is by no means the whole story. The unwillingness of major banks to bid more aggressively for these funds is an important factor. This unwillingness to fully arbitrage the gap between the IOER rate and the effective federal funds rate is another consequence of the lack of balance sheet capacity in the banking sector. Although we are exploring ways to remove most of the GSE effect from the picture, even if we were to be successful in doing this, we expect that the balance sheet constraints would still be powerful enough to cause the effective federal funds rate to trade soft relative to the target. Also, if the GSE federal funds volumes were removed, it is not clear what the effective target would represent because trading volumes could then turn out to be very, very low. The drop in the effective federal funds rate has been accompanied by a corresponding drop in other short-term interest rates. In particular, general collateral repo rates have collapsed almost all the way to zero (exhibit 29). This is likely to lead to a rise in Treasury fails because, when general collateral repo rates are very low, the cost of shorting Treasury securities becomes negligible. As fails climb, in turn, this erodes market function in the Treasury market and reduces the usefulness of the Treasury market as a hedging vehicle for other fixed-income assets. The effect of fails on Treasury market function can be seen in exhibit 30, which shows how errors in our Treasury yield curve model have increased as short-term interest rates have fallen close to zero. In terms of monetary policy expectations, the federal funds rate futures curves (exhibit 31) and the Eurodollar futures curves (exhibit 32) continue to shift lower. However, with the effective federal funds rate persistently trading below the target rate, it is unclear how much of this shift represents a change in expectations about what the Committee will do with respect to the target. The primary dealer credit survey sheds considerably more light here. As shown in exhibits 33 and 34, rate expectations have shifted lower since the last FOMC meeting. All 16 respondents to our most recent survey expect the FOMC to reduce the target, with most (13 out of 16) calling for a 50 basis point reduction in the target rate. No dealer expects a 25 basis point cut at this meeting. Two are at a 75 basis point cut, and one anticipates a 100 basis point reduction in the target rate. A slim majority--9 out of 16--expect a 50 basis point target to be the trough for the target rate. Most expect that the FOMC will not cut the target at future meetings, and no rate hikes are expected by anyone until the second half of 2009 at the earliest. Comparing exhibits 33 and 34, the most recent survey shows considerably less dispersion in the four-quarters-ahead federal funds rate forecasts. Finally, for completeness, I include our standard chart on inflation expectations as measured by the Board's and Barclays' measures of the five-year, five-year-forward breakeven inflation rate (exhibit 35). I don't think these breakeven rates provide much information right now because the TIPS market has been heavily influenced by the sharp fall in CPI inflation that will accrue to TIPS over the next few months and by the growing illiquidity of TIPS versus nominal Treasuries. Interestingly, the most recent primary dealer survey shows no change in five-year, five-year-forward expectations for CPI inflation, with the average of the group remaining at 2.4 percent. There is, however, somewhat greater dispersion on both sides indicating uncertainty about how successful the Federal Reserve will be in keeping core PCE inflation in the ""comfort zone"" of 1� to 2 percent on a longer-term basis (exhibit 36). There were no foreign operations during this period. I request a vote as always to ratify the operations conducted by the System Open Market Account since the October FOMC meeting. Of course, I am very happy to take questions. " CHRG-111hhrg52261--117 STATEMENT OF DAWN DONOVAN Ms. Donovan. Good afternoon, Chairwoman Velazquez, Ranking Member Graves, and members of committee. My name is Dawn Donovan, and I am testifying today on behalf of the National Association of Federal Credit Unions, NAFCU. I serve as the President and CEO of Price Chopper Employees Federal Credit Union in Schenectady, New York. Our credit union has seven employees, approximately 4,500 members in six States and just over $19 million in assets. NAFCU and the entire credit union community appreciate the opportunity to participate in this discussion regarding financial regulatory restructuring and its impact on America's credit unions. It is widely recognized that credit unions did not cause the current economic downturn; however, we believe we can be a important part of the solution. Credit unions have fared well in the current economic environment and as a result many have capital available. Surveys of NAFCU member credit unions have shown that many are seeing increased demand for mortgage and auto loans as other lenders leave the market. Additionally, a number of small businesses who have lost important lines of credit from other lenders are turning to credit unions for the capital that they need. Our Nation's credit unions stand ready to help in this time of crisis and unlike other institutions have the assets to do so. Unfortunately, an antiquated and arbitrary member business cap prevents credit unions from doing more for America's small business community. It is with this in mind that NAFCU strongly supports H.R. 3380, the Promoting Lending to America's Small Businesses Act of 2009. This important piece of legislation would raise the member-business lending cap to 25 percent of assets, while also allowing credit unions to supply much-needed capital to underserved areas which have been among the hardest hit during the current economic downturn. NAFCU also strongly supports the reintroduction of the Credit Union Small Business Lending Act, which was first introduced by Chairwoman Velazquez in the 110th Congress. As the current Congress and administration mull regulatory reform, NAFCU believes that the current regulatory structure for credit unions has served the 92 million American credit union members well. As not-for-profit member-owned cooperatives, credit unions are unique institutions in the financial services arena and make up only a small piece of the financial services pie. We believe that NCUA should remain the independent regulator of credit unions and are pleased to see the administration's proposal would maintain this independence as well as the Federal credit union charter. NAFCU also believes that the proposal is well intentioned in its effort to protect consumers from the predatory practices that led to the current crisis. We feel there have been many unregulated bad actors pushing predatory products onto consumers, and we applaud efforts to address this abuse. It is with this in mind that we can support the creation of the Consumer Financial Protection Agency, CFPA, which would have authority over nonregulated institutions that operate in the financial services marketplace. However, NAFCU does not believe such an agency should be given authority over regulated federally insured depository institutions, and opposes extending this authority to credit unions. As the only not-for-profit institutions that would be subject to the CFPA, credit unions would stand to get lost in the enormity of the proposed agency. Giving the CFPA the authority to regulate, examine, and supervise credit unions, already regulated by the NCUA, would add an additional regulatory burden and cost to credit unions. Additionally, it could lead to situations where institutions regulated by one agency for safety and soundness find their guidance in conflict with the regulator for consumer issues. Such a conflict will result in diminished services to credit union members. Credit unions already fund the budget for NCUA. As not-for-profits, credit unions cannot raise moneys from stock sales or capital markets. This money comes from their members' deposits, meaning credit union members would disproportionately feel the cost burden of a new agency. However, NAFCU also recognizes that more should be done to help consumers and look out for their interests. We would propose that rather than extending the CFPA to federally insured depository institutions, each functional regulator create a new strengthened office on consumer protection. We were pleased to see the NCUA recently announce its intention to create such an office. Consumer protection offices at the functional regulators will ensure those regulating consumer issues have knowledge of the institutions they are examining and guidance on consumer protection. This is particularly important to credit unions as they are regulated and structured differently from others. We believe such an approach would strengthen consumer protection while not adding unnecessary regulatory burden. Part of avoiding that burden will be to maintain a level of Federal preemption so small institutions like mine, with members in several States, are not overburdened by a wide variety of State laws. In conclusion, while there are positive aspects to consumer protection and regulatory reform, we believe Federal credit unions continue to warrant an independent regulator handling safety and soundness and consumer protection matters. I thank you for the opportunity to appear before you on behalf of NAFCU and would welcome any questions that you may have. " FinancialCrisisReport--21 Subprime loans provided new fuel for the securitization engines on Wall Street. Federal law does not define subprime loans or subprime borrowers, but in 2001, guidance issued by federal banking regulators defined subprime borrowers as those with certain credit risk characteristics, including one or more of the following: (1) two or more 30-day delinquencies in the last 12 months, or one or more 60-day delinquencies in the last 24 months; (2) a judgment or foreclosure in the prior 24 months; (3) a bankruptcy in the last five years; (4) a relatively high default probability as evidenced by, for example, a credit score below 660 on the FICO scale; or (5) a debt service-to-income ratio of 50% or more. 17 Some financial institutions reduced that definition to any borrower with a credit score below 660 or even 620 on the FICO scale; 18 while still others failed to institute any explicit definition of a subprime borrower or loan. 19 Credit scores are an underwriting tool used by lenders to evaluate the likelihood that a particular individual will repay his or her debts. FICO credit scores, developed by the Fair Issacs Corporation, are the most widely used credit scores in U.S. financial markets and provide scores ranging from 300 to 850, with the higher scores indicating greater creditworthiness. 20 High risk loans were not confined, however, to those issued to subprime borrowers. Some lenders engaged in a host of risky lending practices that allowed them to quickly generate a large volume of high risk loans to both subprime and prime borrowers. Those practices, for example, required little or no verification of borrower income, required borrowers to provide little or no down payments, and used loans in which the borrower was not required to pay down the loan amount, and instead incurred added debt over time, known as “negative amortization” loans. Some lenders offered a low initial “teaser rate,” followed by a higher interest rate that 16 A Federal Reserve Bank of New York research paper identifies the top ten subprime loan originators in 2006 as HSBC, New Century, Countrywide, Citigroup, WMC Mortgage, Fremont, Ameriquest Mortgage, Option One, Wells Fargo, and First Franklin. It identifies the top ten originators of subprime mortgage backed securities as Countrywide, New Century, Option One, Fremont, Washington Mutual, First Franklin, Residential Funding Corp., Lehman Brothers, WMC Mortgage, and Ameriquest. “Understanding the Securitization of Subprime Mortgage Credit,” by Adam Ashcraft and Til Schuermann, Federal Reserve Bank of New York Staff Report No. 318, (3/2008) at 4. 17 Interagency “Expanded Guidance for Subprime Lending Programs, (1/31/2001) at 3. See also “Understanding the Securitization of Subprime Mortgage Credit,” by Adam Ashcraft and Til Schuermann, Federal Reserve Bank of New York Staff Report No. 318, (3/2008) at 14. 18 See, e.g., 1/2005 “Definition of Higher Risk Lending,” chart from Washington Mutual Board of Directors Finance Committee Discussion, JPM_WM00302979, Hearing Exhibit 4/13-2a; 4/2010 “Evaluation of Federal Regulatory Oversight of Washington Mutual Bank,” report prepared by the Offices of Inspector General at the Department of the Treasury and Federal Deposit Insurance Corporation, at 8, Hearing Exhibit 4/16-82. 19 See, e.g., Countrywide Financial Corporation, as described in SEC v. Mozilo , Case No. CV09-03994 (USDC CD Calif.), Complaint (June 4, 2009), at ¶¶ 20-21. 20 To develop FICO scores, Fair Isaac uses proprietary mathematical models that draw upon databases of actual credit information to identify factors that can reliably be used to predict whether an individual will repay outstanding debt. Key factors in the FICO score include an individual’s overall level of debt, payment history, types of credit extensions, and use of available credit lines. See “What’s in Your FICO Score,” Fair Isaac Corporation, http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx. Other types of credit scores have also been developed, including the VantageScore developed jointly by the three major credit bureaus, Equifax Inc., Experian Group Ltd., and TransUnion LLC, but the FICO score remains the most widely used credit score in U.S. financial markets. took effect after a specified event or period of time, to enable borrowers with less income to make the initial, smaller loan payments. Some qualified borrowers according to whether they could afford to pay the lower initial rate, rather than the higher rate that took effect later, expanding the number of borrowers who could qualify for the loans. Some lenders deliberately issued loans that made economic sense for borrowers only if the borrowers could refinance the loan within a few years to retain the teaser rate, or sell the home to cover the loan costs. Some lenders also issued loans that depended upon the mortgaged home to increase in value over time, and cover the loan costs if the borrower defaulted. Still another risky practice engaged in by some lenders was to ignore signs of loan fraud and to issue and securitize loans suspected of containing fraudulent borrower information. CHRG-111shrg52619--193 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM MICHAEL E. FRYZELQ.1. The convergence of financial services providers and financial products has increased over the past decade. Financial products and companies may have insurance, banking, securities, and futures components. One example of this convergence is AIG. Is the creation of a systemic risk regulator the best method to fill in the gaps and weaknesses that AIG has exposed, or does Congress need to reevaluate the weaknesses of federal and state functional regulation for large, interconnected, and large firms like AIG?A.1. NCUA has previously expressed its support for establishing a systemic risk regulator to monitor financial institution regulators, issue principles-based regulations and guidance, and establish general safety and soundness guidance for financial regulators under its control. This oversight entity would monitor systemic risk across institution types. \7\ This broad oversight would complement NCUA's more in-depth and customized approach to regulating federally insured credit unions.--------------------------------------------------------------------------- \7\ For purposes of this response, financial institutions include commercial banks and other insured depository institutions, insurers, companies engaged in securities and futures transactions, finance companies, and specialized companies established by the government as defined by the Treasury Blueprint. Individual financial regulators would implement and enforce the established guidelines for the institutions they regulate.--------------------------------------------------------------------------- Credit unions are unique, cooperative, not-for-profit entities with a statutory mandate to serve people of modest means. NCUA believes the combination of federal functional regulators performing front-line examinations and oversight by a systemic risk regulator would be a good method to fill weaknesses exposed by AIG. Additionally, because of the small size of most credit unions and the limitations placed on their charters, credit unions generally do not become part of a large conglomerate of business entities.Q.2. Recently there have been several proposals to consider for financial services conglomerates. One approach would be to move away from functional regulation to some type of single consolidated regulator like the Financial Services Authority model. Another approach is to follow the Group of 30 Report which attempts to modernize functional regulation and limit activities to address gaps and weaknesses. An in-between approach would be to move to an objectives-based regulation system suggested in the Treasury Blueprint. What are some of the pluses and minuses of these three approaches?A.2. Credit unions have not become financial service conglomerates due to limitations within the laws impacting credit unions including restricted fields of membership and limited potential activity. Therefore, the functional regulatory approach currently in place has worked in the credit union industry. While there is no perfect regulatory model to adopt and follow that addresses all of the current issues in the financial services industry, we can take portions from different plans to create a regulatory system that meets the needs of the current economy. A modernized functional regulatory system would divide the financial services industry into at least five categories: credit unions, banks, insurance, securities, and futures. This approach would allow the functional regulators to operate with expertise within their segment of the financial institutions. A functional regulator provides regulation for the specific issues facing their financial sector. This approach also allows a single regulator to possess the information and authority necessary to completely oversee the regulated entities within their segment of the industry while eliminating inefficiencies made with multiple overseers of the same entity. One drawback of this system is the possibility of regulators addressing the same issue with different approaches. One way to address this issue is the addition of a systemic oversight agency to the financial services industry. A systemic oversight agency could issue principles-based regulations and guidance, promoting uniformity in the supervision of the industry, while allowing the functional regulators to implement the regulations and guidance in a manner most appropriate for their financial segment. This type of structure would help preserve the different segments of the industry and maintain the checks and balances afforded by the different segments within the industry. With the single consolidated regulator approach, authority over all aspects of regulated institutions would be established under one regulator. This approach would allow the regulator to possess all information and authority regarding individual institutions, which would eliminate inefficiencies of multiple overseers for the same institution. This approach would also ensure the financial services industry operated under a consistent regulatory approach. However, this approach could result in the loss of specialized attention and focus on the various distinct segments of the financial institutions. An agency responsible for all institutions might focus on the larger institutions where the systemic risk predominates, potentially to the detriment of smaller institutions. For example, as federally insured credit unions are generally the smaller, less complex institutions in a consolidated financial regulator arrangement, the unique character of credit unions would quickly be lost, absorbed by the for-profit model and culture of other financial institutions. Loss of credit unions as a type of financial institution would limit access to the affordable services for persons of modest means that are offered by credit unions. An objectives-based regulatory approach as outlined in the Treasury Blueprint (market stability, prudential, and business conduct regulators) would ensure all financial institutions operated under a consistent regulatory approach. However, like the single consolidated regulator, this approach could also result in the loss of specialized attention and focus on the distinct segments of financial institutions, thus harming the credit union charter. Again, each regulator might focus on the larger financial institutions where the systemic risk predominates, while not addressing the different types of risks found in the smaller institutions. This approach also would result in multiple regulators for the same institution, where no single regulator possessed all of the information and authority necessary to monitor the overall systemic risk of the institution. In addition, disputes between the regulators regarding jurisdiction over the different objectives would arise. Inefficiencies would be created with multiple regulators supervising the same institution. Again, the focus on the objective rather than the charter could potentially harm the credit union industry where credit unions only comprise a small part of the financial institution community. In closing, the approach selected to regulate the financial services providers must protect the unique regulatory needs of the various components of the financial sectors, including the credit union industry.Q.3. If there are institutions that are too big to fail, how do we identify that? How do we define the circumstance where a single company is so systemically significant to the rest of our financial circumstances and our economy that we must not allow it to fail?A.3. If the definition of ``too big to fail'' encompasses only those institutions that are systemically significant enough where their failure would have an adverse impact on financial markets and the economy, then credit unions would not be considered too big to fail. Within the credit union system there are regulatory safeguards in place to reduce the potential for ``too big to fail'' entities. The field of membership restrictions that govern membership of the credit union limit the potential for any systemic risk. The impact of a failure of a large natural person credit union would be limited to any cost of the failure, which would be passed on to all other federally insured credit unions via the assessment of a premium should the equity level of the NCUSIF fall below the required level.Q.4. We need to have a better idea of what this notion of too big to fail is--what it means in different aspects of our industry and what our proper response to it should be. How should the federal government approach large, multinational and systemically significant companies?A.4. In large, multinational and systemically significant institutions, federal regulators should take an aggressive approach to examining and monitoring. As issues are discovered, the regulator must quickly and firmly take the appropriate action before the issue escalates. Very few federally insured credit unions have a multinational presence. Due to field of membership limitations, only credit unions where a portion of their members are located in foreign counties, such as a Department of Defense related credit union, would have multinational exposure. \8\ In those cases, there is limited multinational significance to the credit union business model.--------------------------------------------------------------------------- \8\ Credit unions are chartered to serve a field of membership that shares a common bond such as the employees of a company, members of an association, or a local community. Therefore, credit unions may not serve the general public like other financial institutions and the credit unions' activities are largely limited to domestic activities, which has minimized the impact of globalization in the credit union industry.Q.5. What does ``fail'' mean? In the context of AIG, we are talking about whether we should have allowed an orderly Chapter ---------------------------------------------------------------------------11 bankruptcy proceeding to proceed. Is that failure?A.5. NCUA regulates federally insured credit unions, which do not file Chapter 11 bankruptcies. However, federally insured credit unions can become insolvent and be liquidated. No member of a federally insured credit union has ever lost a penny of insured shares. In order to preserve confidence in the credit union industry, NCUA usually pays out members within three days from the time a federally insured credit union fails. NCUA has an Asset Management and Assistance Center that is available to quickly handle credit union liquidations and perform management and asset recovery. Based on the requirements set forth in 12 U.S.C. 1790d of the Federal Credit Union Act, NCUA considers a credit union in danger of closing (a potential failure) when the credit union: Is subject to mandatory conservatorship, liquidation or ``other corrective action'' for not maintaining required levels of capital; Is subject to discretionary conservatorship or liquidation or is required to merge for not maintaining required levels of capital; Is subject to a high probability of sustaining an identifiable loss (e.g., fraud, unexpected and sudden outflow of funds, operational failure, natural disaster, etc.) and could not maintain required levels of capital, so that it would be subject to conservatorship or liquidation. ------ FOMC20080430meeting--180 178,MR. KOHN.," Thank you, Mr. Chairman. I think I can be brief by just associating myself with the comments of President Stern. This is a difficult decision. You could make a case for either of these. But on balance, I think we should be lowering interest rates 25 basis points, as under alternative B. As President Stern said, I don't think just subtracting past inflation from the nominal federal funds rate is a good metric for where the stance of policy is today. It would be if financial conditions were consistent with historical relationships, but they're not. We have very tight credit conditions in many sectors of the market, and a zero or negative federal funds rate means a very different thing today than it did even in the early 1990s, Gary, because then you had the banking system broken but the securities markets working. Now you have the banking system broken and the securities markets not working very well. So I think we have stronger--I guess Greenspan called them ""50 mile an hour""--headwinds. I would say they are 60 or 70 today, at least for now. We expect the headwinds to abate; and as they abate, policy will look a lot more accommodative. But I don't think we really have insurance right now against the contingency that the headwinds don't abate very quickly or even get worse, or against the contingency that the staff is right and we are entering a recessionary period in which consumption and investment fall short of what the fundamentals would suggest. I think that 25 basis points probably won't buy us much, if any, insurance, but it will get policy calibrated a little better to the situation that we are facing today. I expect a small decrease in the funds rate to be consistent with further increases in the unemployment rate--and everybody does, I think, judging from the central tendencies of the forecast--which will put downward pressure and help to contain inflation. I agree that there is an upside risk from continued increases in commodity prices that feed through, as President Plosser noted, into core inflation. I think that this is a very different situation from the 1970s. I looked this morning at the Economic Report of the President, at those tables in the back. The stage for the 1970s was set in the 1960s. Core inflation rose from 1� percent in the mid-1960s to 6� percent in 1969. That's a situation, obviously, in which inflation expectations can become unanchored, and then these relative price shocks feed through much more into inflation expectations. Looking in the Greenbook, Part 2, page II-32, every measure of core inflation for 2007 was lower than the measure of core inflation for 2006, and half of them--these are Q4-to-Q4 measures of core inflation--are lower than for 2005. So we are not in a situation of a gradual upcreep in core inflation, which I think was what set the stage for the 1970s. I don't expect a small decrease in interest rates to result in higher inflation through this dollar�commodity price�inflation expectations channel either. The decrease in interest rates is already in the markets. If anything, a statement like alternative B might firm rates a bit; and taking out ""downside risks"" and ""act in a timely manner"" reinforces the notion that the Federal Reserve is not poised to ease any more. I wouldn't expect interest rates to go down; therefore, I wouldn't expect the dollar to go down, and I wouldn't expect commodity prices to go up from this. I think the markets reacted very well over the intermeeting period to incoming data. They saw the tail risk decrease. They raised interest rates. The dollar firmed. They put a U shape in our interest rate path. It seems to me that path is very close to what many of us said we expected and thought was appropriate, give or take � point, for the federal funds rate over the coming couple of years. I don't see any reason to act in a way that changes those expectations; I think the market expectations are fine. I wouldn't lower interest rates � point just to confirm market expectations. I think it is the right thing to do, and I don't see any reason to lean against it to change expectations. I think that expectations are lined up pretty well with our objectives. Thank you, Mr. Chairman. " CHRG-111shrg57322--587 Mr. Viniar," Chairman Levin, Ranking Member Coburn, and Members of the Subcommittee, good afternoon. My name is David Viniar. I have been Chief Financial Officer of Goldman Sachs since 1999. I am responsible for risk management, financial control and reporting, and financing our business, among other duties. I appreciate the opportunity to appear before the Subcommittee and I will comment here on our risk philosophy and our approach to risk management.--------------------------------------------------------------------------- \1\ The prepared statement of Mr. Viniar appears in the Appendix on page 216.--------------------------------------------------------------------------- As a global investment bank and financial intermediary, Goldman Sachs integrates advice and capital with its risk management capabilities to serve a broad range of largely institutional clients. In doing so, we often take on principal risk to help clients achieve their objectives. For example, we may facilitate block offerings, provide structured solutions, or extend credit. We routinely evaluate, price, and distribute risk across the spectrum according to the specific risk appetites of our institutional clients. We know that we will sometimes incur losses, but as a core part of our business model, we proactively manage our risk to minimize these losses. When we commit capital to buy or sell financial instruments, extend credit, or invest alongside our clients, we accumulate both long and short positions that give rise to liquidity, credit, and market risks. We deploy a range of risk management capabilities to price the risks of each transaction appropriately, keep the firm's overall exposures within risk limits, and establish offsetting positions, or sell and buy positions, as necessary to control overall exposure. Our approach is to understand the risks we are taking, analyze and quantify them, and keep a firm grip on their current market value. We carry virtually our entire inventory of financial instruments at fair market value, with changes reflected in our daily P&L. Such daily marking of our positions was a key reason we decided to start reducing our mortgage risk as market conditions were deteriorating at the end of 2006. I would like to give you a sense for how we managed our risk during the period leading up to the crisis. Through the end of 2006, we were generally long in exposure to residential mortgages and mortgage-related products. In that December, however, we began to experience a pattern of daily losses in our mortgage-related P&L. P&L can itself be a very valuable risk metric and I personally read it every day. I called a meeting to discuss the situation with the key people involved in running the mortgage business. We went through our positions and debated views on the mortgage market in considerable detail. While we came to no definitive conclusion about how the overall market would develop in the future, we became collectively concerned about the higher volatility and recent price declines in our subprime mortgage-related positions. As a result, we decided to attempt to reduce our exposure to these positions. We wanted to get closer to home. We proceeded to sell certain positions outright and hedge our long positions in an attempt to achieve these results. As always, the clients who bought our long positions or other similar positions had a view that they were attractive positions to purchase at the price they were offered. As with our own views, their views sometimes proved to be correct and sometimes incorrect. We continued to reduce our positions in these products over the course of 2007. We were generally successful in reducing this exposure to the extent that, on occasion, our portfolio traded short. When that happened, even if these short positions were profitable, given the ongoing high volatility and uncertainty in the market, we tended to attempt to then reduce these short positions to again get closer to home. This situation reversed itself in 2008, however, when the portfolio tended to trade long, and as a result, despite the fact that our franchise enabled the firm to be profitable overall, we lost money on residential mortgage-related products in that year. While the tremendous volatility in the mortgage market caused periodic large losses on long positions and large gains on offsetting short positions, the net of which could have appeared to be a substantial gain or loss on any day, in aggregate, these positions had a comparatively small effect on our net revenues. In 2007, total net revenues from residential mortgage-related products, both longs and shorts together, were less than $500 million, approximately 1 percent of Goldman Sachs's overall net revenues. And in 2007 and 2008 combined, our net revenues in this area were actually negative. For Goldman Sachs, weathering the mortgage market meltdown had nothing to do with prescience or betting on or against anything. More mundanely, it had everything to do with systematically marking our positions to market, paying attention to what those marks were telling us, and maintaining a disciplined approach to risk management. Thank you, and I am happy to take your questions. Senator Levin. Thank you very much. Mr. Broderick. TESTIMONY OF CRAIG W. BRODERICK,\1\ CHIEF RISK OFFICER, THE CHRG-111hhrg54872--180 Mr. Scott," Thank you, Mr. Chairman. I would just like to kind of focus my remarks on unintended consequences, one-size-fits-all dangers of this, as well as the confusion between State and Federal laws as we move forward. It is an important legislation. Let's take my first problem of unintended consequences and whether or not this would work, particularly with some unique situations. I am sure you all are familiar with the Farm Credit Administration. The Farm Credit Administration is very, very unique. They already have what they call a borrowers' bills of rights, which basically covers much of what we are attempting to do in this bill, resulting in if they were into this duplicatory obligations, burdensome regulatory concerns as well. Consumer lending is a very, very small part of what they do. Mortgage lending, for example, is only allowed in communities with less than 2,500 individuals. Their products were not anywhere near the toxic level that caused the problem in the first place. So my question is, would not we be doing a better service here if we allowed the farm credit to continue to operate under its own current regulatory process away from this legislation? I take it all of you agree that it would be the best thing to do in this situation, to allow farm credit. The reason I mention that is, also, farm credit does not come under the jurisdiction of financial services. It is an agricultural area. And I am simply saying that it makes sense--this is a complex, complicated area, covers a lot of the waterfront when we are dealing with the financial services industry. And it might be wise as we move forward with this to look inward-outward instead of outward-inward. And I think that what I am getting from the committee here is that you agree that the Farm Credit Administration should be left away from this or doing what they are doing with the bill of rights; weren't a part of the problem in the first place; and this would be a duplication. " CHRG-111shrg54589--121 PREPARED STATEMENT OF SENATOR MIKE CRAPO Recent events in the credit markets have highlighted the need for greater attention to risk management practices and the counterparty risk in particular. The creation of clearinghouses and increased information to trade information warehouses are positive steps to strengthen the infrastructure for clearing and settling credit default swaps. While the central counterparty clearing and exchange trading of simple, standardized contracts has the potential to reduce risk and increase market efficiency, market participants must be permitted to continue to negotiate customized bilateral contracts in over-the-counter markets. Many businesses use over-the-counter derivatives to minimize the impact of commodity price, interest rate, and exchange rate volatility in order to maintain stability in earnings and predictability in operations. If Congress overreaches and bans or generates significant uncertainty regarding the legitimacy of decisions to customize individual OTC derivatives transactions there will be enormous negative implications on how companies manage risk. At this time I would like to highlight a few examples from end users about what are the possible effects of severely restricting access to customized over-the-counter derivatives on companies' ability to manage risk and on the prices they charge customers.v David Dines, President of Cargill Risk Management: ``While margining and other credit support mechanisms are in place and utilized every day in the OTC markets, there is flexibility in the credit terms, credit thresholds and types of collateral that can be applied. This flexibility is a significant benefit for end users of OTC derivatives such as Cargill in managing working capital. Losing this flexibility is particularly concerning because mandatory margining will divert working capital from investments that can grow our business and idle it in margin accounts. While it depends on market conditions, the diversion of working capital from Cargill from margining could be in excess of $1 billion. Multiply this across all companies in the U.S. and ramifications are enormous, especially at a time when credit is critically tight.'' Kevin Colgan, Corporate Treasurer of Caterpillar: ``Our understanding of currently pending regulation in this area is that it would require a clearing function which would standardize terms like duration and amount. Any standardization of this type would prohibit us from matching exactly the terms of the underlying exposure we are attempting to hedge. This, in turn, would expose us to uncovered risk and introduce needless volatility into our financial crisis.'' Mark Grier, Vice Chairman of Prudential Financial: ``Without customized OTC derivatives, Prudential would be incapable of closely managing the risks created in selling life insurance, offering commercial loans, and proving annuities for retirement.'' John Rosenthal, Chief Hedging Officer of MetLife: ``Standardized derivatives cannot be used effectively to hedge all types of financial risk. Any increased risks would result in higher costs to offer and maintain these products. In either situation the increased costs of an inefficient derivatives market would be reflected in the pricing to our customers. To the extent the costs and/or risks associated with an inability to appropriately hedge these products became prohibitive; these products could be no longer available to customers.'' Janet Yeomans, Vice President and Treasurer of 3M: ``Not all OTC derivatives have put the financial system at risk and they should not all be treated the same. The OTC foreign exchange, commodity, and interest rate markets have operated uninterrupted throughout the economy's financial difficulties. We urge policy makers to focus on the areas of highest concern.'' At this time, I would like to submit into the record the complete letters. It is possible that I will receive additional letters in the next few days and I would also like to enter those letters in the record. While the derivatives market may seem far removed from the interests and concerns of consumers and jobs that is clearly not the case. Legislative proposals to alter the regulatory framework of over-the-counter derivatives is a very technical subject matter and the potential for legislation to have unintended consequences of legitimate transactions is considerable. We need to better understand the following questions: How do businesses use customized OTC derivatives to help stabilize prices and mitigate risk? What are the possible effects of severely restricting access to customized OTC derivatives on businesses ability to manage risk and on the prices they charge customers? What safeguards are in place to ensure that derivatives portfolios are a tool for hedging risk, rather than a source of risk? What does standardized mean, and how much of the OTC markets can and should be shifted on exchanges? ______ CHRG-111hhrg50289--10 Mr. Heacock," Chairwoman Velazquez, Ranking Member Graves, and members of the Committee, thank you so much for the opportunity to testify on behalf of the Credit Union National Association. I am honored to address the impact SBA lending has on our local economy, our credit union, and our members, and to suggest ways to improve SBA programs. Black Hills was first authorized to do SBA lending in January 2003, and we truly value our partnership with the SBA. We wrote more SBA loans than any other financial institution in South Dakota during 2008, 29 loans for a total of $1.6 million. We are looking forward to working with new SBA Administrator Karen Hills and find working with the SBA beneficial to the credit union and our members for several reasons. We have a number of members who started small businesses using SBA loan funds while continuing to work at their primary job as their main source of income. The SBA helped us be there for our members, and this has resulted in additional employment opportunities. There is additional risk to these types of borrowers, and quite frankly, other lenders shy away from helping them because there is not a proven cash flow. We are able to do this type of lending because of the guarantee that SBA provides. The programs allow us to help the borrower who comes in and may not have the equity investment we would generally like to see but has a good business plan. The SBA helps us create an acceptable level of risk, and it is a win-win situation for all of us, the credit union, the SBA, and the borrower. CUNA is a strong supporter of the 7(a) and 504 loan programs, essential tools for achieving our mission to serve the needs of members. However, several important factors discourage more credit unions from participating as SBA lenders. First, the statutory cap on credit union MBLs restricts the ability of credit unions from helping their members even more. Even though the cap does not apply to SBA loans, it is a real barrier, keeping some credit unions from establishing an MBL program at all. Not all loans fit SBA parameters, and credit unions are reluctant to initiate an MBL program when they may reach the cap in a fairly short order. CUNA is also aware that some lenders have not had a positive experience with the SBA, citing the application process, fees, and time of decision making. In that vein, we think there are ways to improve the work that is done by the SBA. As the Committee reviews SBA programs, we encourage Congress to make additional funds available to the agency so that fees can remain low and the guarantees can remain sufficient. We appreciate Congress setting aside $375 million for the temporary elimination of fees and raising the guaranty percentage on some loans to 90 percent as part of the Recovery Act. In closing, credit union business lending represents just over one percent of the depository institution business lending market. Credit unions have about $33 billion in outstanding business loans compared to $3.1 trillion for banking institutions. We are not financing skyscrapers or sports arenas. We are making loans to members who own and operate small businesses. Despite the financial crisis, the chief obstacle for credit union business lending is not the availability of capital. Credit unions are, in general, well capitalized. Rather, the chief obstacle is the statutory limits imposed by Congress in 1998. Under current law, credit unions are restricted from member business lending in excess of 12.25 percent of their total assets. This arbitrary cap has no basis in either actual credit union business lending or safety and soundness considerations. And the U.S. Treasury Department found that delinquencies and charge-offs for credit union business loans were much lower than that for either banks or thrifts. The cap effectively limits entry into the business lending arena on the part of small and medium size credit unions, the vast majority of all credit unions, because the costs and requirements, including the need to hire and retain staff with business lending experience exceed resources of many credit unions. While we support strong regulatory oversight of member business lending, there is no safety and soundness rationale for the cap. There is, however, a significant economic reason to eliminate the cap. America's small business needs access to capital. We estimate that if the cap on credit union business lending were removed, credit unions could safely and soundly provide as much as $10 billion for new loans for small businesses within the first year. This is an economic stimulus that would not cost the taxpayers a dime or increase the size of government. Madam Chairwoman, thank you very much for convening this hearing and inviting me to testify. I look forward to answering the Committee's questions. [The prepared statement of Mr. Heacock is included in the appendix.] " CHRG-110hhrg46594--419 Mr. Neugebauer," Thank you, Mr. Chairman. Annette, I want to go back to your testimony about the financing piece of it because there are so many pieces to this, and I think what our committee has to look at is those pieces where we probably have some jurisdiction. In the financing piece, how many--do you have a handle on how many people are coming to your dealership and would like to buy a car but you are not able to arrange financing for them? Is that 100 percent of the time, 90 percent of the time, 20 percent? Can you give me a handle on what you are facing on a retail financing contract? Ms. Sykora. Well, Congressman, the first problem we have is getting the people to come to the showroom because there is a lack of consumer confidence and they begin with the feeling that there is no credit available. So even if they come to the showroom, they are already feeling that credit might not be available. Now, retail credit is available. You have to have a stable job and you have to have good credit. But because they are in many--and we heard that earlier today. There are many banks and credit unions that do have money to lend on the retail side. The problem is there are kind of three pieces here. You have working capital for the dealers, you have the inventory financing, or what we call floor plan, and then there is retail. And we are working with Treasury because of the tightening and elimination of the securitization on the lines, and that is what is impacting the availability of retail credit. So, you know, I think that is where we need immediate and urgent help, is access. " CHRG-111shrg52619--205 RESPONSE TO WRITTEN QUESTIONS OF SENATOR HUTCHISON FROM SCOTT M. POLAKOFFQ.1. Will each of you commit to do everything within your power to prevent performing loans from being called by lenders? Please outline the actions you plan to take.A.1. OTS is encouraging financial institutions to develop effective loan modification programs in lieu of calling loans, whether they are performing or delinquent. OTS and OCC are working jointly to produce a quarterly Mortgage Metrics Report that analyzes mortgage servicing data and also provides data on the affordability and sustainability of loan modifications. The 2008 fourth quarter report revealed that delinquencies were still rising, but financial institutions were also increasing efforts aimed at home retention, including loan modifications or payment plans. The first quarter 2009 data continued to show increases in seriously delinquent prime mortgages and a jump in the number of foreclosures in process across all risk categories as a variety of moratoria on foreclosures expired during the first quarter of 2009. A positive development is the significant increase in the number of modifications made by servicers. In addition to the increase in the overall numbers of modifications, servicers also implemented a higher percentage of modifications that reduced monthly payments than in previous quarters. Modifications with lower payments continued to show fewer delinquencies each month following modification than those that left payments unchanged or increased payments. Therefore, even in the midst of an overall worsening of conditions in mortgage performance, there is a strong industry response in the form of increased modifications. The OTS will continue to monitor the types of home retention actions implemented by servicers in efforts to stem home foreclosure actions. ------ FinancialCrisisInquiry--10 Having to fair value our assets on a daily basis and see the results of that marking in our P&L forced us to cut risk regardless of market or individual views, estimates or expectations. Throughout 2007 we were committed to reducing certain of our risk exposures, even though we sold at prices many in the market, including at times ourselves, thought were irrational or temporary. After the fact, it was easy to be convinced that the signs were visible and compelling. In hindsight, events not only looked predictable, but sometimes looked like they were obvious or known. The truth is that no one knows what is going to happen. And that recognition defined our approach to risk management. We believe key attributes of our strategy, culture and processes were validated during the extraordinary events and macro-economic uncertainty of the past year. But they have also prompted change within our firm. Over the last 18 months our balance sheet has been reduced by a quarter, while our capital has increased by over a half. Our Basel I and tier one capital ratio has increased to 14.5 percent through earnings generation and the number of capital offerings. Our pool of liquidity was relatively high at the onset of the crisis, but we carry a great deal more cash on our balance sheet than ever before to deal with contingencies. While we believe our firm has produced a strong relationship between compensation and performance, we have announced additional reforms in this area. At our shareholders meeting last year we outlined specific compensation principles. Consistent with those principles, in December, we announced that the firm’s entire management committee will receive 100 percent of their discretionary compensation in the form of shares at risk, which cannot be sold for five years. In addition, we announced that the five-year holding period on shares at risk includes an enhanced recapture provision that will permit the firm to recapture the shares in cases where the employee engaged in materially improper risk analysis or failed sufficiently to raise concerns about risk. FinancialCrisisReport--78 The problems with Long Beach’s loans and securitizations predated the company’s purchase by WaMu in 1999, but continued after the purchase. An internal email at WaMu’s primary federal regulator, the Office of Thrift Supervision (OTS), observed the following with respect to Long Beach’s mortgage backed securities: “Performance data for 2003 and 2004 vintages appear to approximate industry average while issues prior to 2003 have horrible performance. LBMC finished in the top 12 worst annualized NCLs [net credit losses] in 1997 and 1999 thru 2003. LBMC nailed down the worst spot at top loser … in 2000 and placed 3 rd in 2001.” 207 In 2003, Long Beach’s performance deteriorated to the point that WaMu’s legal department put a stop to all Long Beach securitizations until the company improved its operations. 208 An internal review of Long Beach’s first quarter 2003 lending “concluded that 40% (109 of 271) of loans reviewed were considered unacceptable due to one or more critical errors.” 209 According to a 2003 joint report issued by regulators from the FDIC and Washington State: “This raised concerns over LBMC’s ability to meet the representations and warrant[ies] made to facilitate sales of loan securitizations, and management halted securitization activity.” 210 A Long Beach corporate credit review in August 2003 confirmed that “credit management and portfolio oversight practices were unsatisfactory.” 211 As a result of the halt in securitizations, Long Beach had to hold loans on its warehouse balance sheet, which increased by approximately $1 billion per month and reached nearly $5 billion by the end of November 2003. Long Beach had to borrow money from WaMu and other creditors to finance the surge. 212 The joint visitation report noted that unless Long Beach executed a $3 billion securitization by January 2004, “liquidity will be strained.” 213 WaMu initiated a review of Long Beach led by its General Counsel Faye Chapman. 214 Her team evaluated the loans that had accumulated during the halt in securitizations. The joint visitation report noted that of 4,000 Long Beach loans reviewed by WaMu by the end of November 2003, less than one quarter, about 950, could be sold to investors, another 800 were unsaleable, and the rest – over half of the loans – had deficiencies that had to be remediated before a sale could take place. 215 207 4/2005 OTS internal email, Hearing Exhibit 4/13-8(a). 208 Subcommittee interview of Faye Chapman, WaMu General Counsel (2/9/2010). See also 12/21/2005 OTS memorandum, “Long Beach Mortgage Corporation (LBMC),” OTSWMS06-007 0001010, Hearing Exhibit 4/16-31. 209 1/13/2004 report on “Joint Visitation Dated October 14, 2003,” jointly prepared by the FDIC and the State of Washington Department of Financial Institutions, FDIC-E_00102515, at 3, Hearing Exhibit 4/13-8b (citing a Long Beach quality assurance report). 210 Id. 211 Id. (citing a Long Beach Corporate Credit Review report). 212 Id. 213 Id. 214 Subcommittee interview of Fay Chapman (2/9/2010). 215 1/13/2004 report on “Joint Visitation Dated October 14, 2003,” jointly prepared by the FDIC and the State of Washington Department of Financial Institutions, FDIC-E_00102515, at 3, Hearing Exhibit 4/13-8b. CHRG-109hhrg31539--86 Mr. Baker," I thank the chairman. Just to follow up a little bit on Mr. Capuano's remarks, there was, in 1999, H.R. 2924, which would have required hedge funds above a certain size to disclose information to the Federal Reserve for the intended purpose of identifying potential systemic risk events, and I will forward that over for comment and advisory. I, in retrospect, look at the product and feel that it needs to be made more clear that no proprietary disclosure be made to ensure that it is only a blind view as to who is sitting at what table and--beyond what the counterparty risk disclosure may give to you now. I wanted to move quickly to the subject of GSE reform. I read with great interest your response to Senate questions on the matter of portfolio limitations wherein I believe you characterized your view to be that no hard dollar amount nor some arbitrary percentage reduction be made applicable, but rather that some relationship between portfolio scale and mission compliance pursuant to charter requirement be made effective. In given conversations I have had with Secretary Paulson and Director Lockhart on the matter, I, for whatever it is worth, share that view--would like to request that you work with the Director and the Secretary to compound some sort of language that you think would be helpful in breaking the last remaining element I believe that is blocking the adoption of significant and, I think, very badly needed GSE reform. There is another issue that I wanted to get on the record that I think is very important. I am concerned not so much about the domestic economic condition and our ability to maintain a reasonable rate of growth, except for the enhanced global competitive market we now face. I believe there are conditions brought on by our own regulatory constraints that may be inhibiting international capital flows which would generate the job opportunities and, hence, the increased wages which some have expressed concern about. The result is that some regulators have suggested actions that might be helpful. Recently the Chair of FASB has indicated that a move toward a more principles-based accounting methodology might be a way to help industries' current cost of compliance. Chairman Cox has indicated his strong support for the deployment of XBRL to help us move away from the enormous paper-based reporting methodologies that we now have to deal with. Many in the market have expressed some concerns about some of the compliance cost with the Sarbanes-Oxley Act. My last general question is to help us going forward and maintain our U.S. competitive edge, are there certain regulatory areas that you could recommend to the Congress to review where, without diminishing transparency, appropriate disclosure, gauging systemic risk potential--are there things that are now on the books that, in light of our current technological sophistication, are no longer warranted and might be worthwhile to set aside? " CHRG-111shrg56262--13 Mr. Davidson," Good afternoon, Chairman Reed, Ranking Member Bunning, Members of the Subcommittee. More than 2 years since the collapse of the Bear Stearns high-grade structured credit enhanced leverage fund, its name a virtual litany of woes, we are still in the midst of a wrenching economic crisis, brought on at least in part by the flawed structure of our securitization markets. I appreciate the opportunity to share my views on what regulatory and legislative actions could reduce the risk of such a future crisis. I believe that securitization contributed to the current economic crisis in two ways: First, poor underwriting led to unsustainably low mortgage payments and excessive leverage, especially in the subprime and Alt-A markets. This in turn contributed to the bubble and subsequent house price drop. Second, the complexity and obfuscation of some structured products such as collateralized debt obligations caused massive losses and created uncertainty about the viability of key financial institutions. Now to solutions. Boiled down to the essentials, I believe that for the securitization market to work effectively, bondholders must ensure that there is sufficient capital ahead of them to bear the first loss risks of underlying assets; that the information provided to them is correct; that the rights granted to them in securitization contracts are enforceable; that they fully understand the investment structures; and that any remaining risks they bear are within acceptable bounds. If these conditions are not met, investors should refrain from participating in these markets. If bondholders act responsibly, leverage will be limited and capital providers will be more motivated to manage and monitor risks. If this is the obligation of investors, what then should be the role of Government? First, Government should encourage all investors and mandate that regulated investors exercise appropriate caution and diligence. To achieve this goal, regulators should reduce or eliminate their reliance on ratings. As an alternative to ratings, I believe regulators should place greater emphasis or reliance on analytical measures of risk, such as computations of expected loss and portfolio stress tests. Second, Government should promote standardization and transparency in securitization markets. While the SEC, the ASF, and the rating agencies may all have a role in this process, I believe that transforming Fannie Mae and Freddie Mac into member-owned securitization utilities would be the best way to achieve this goal. Third, Government can help eliminate fraud and misrepresentation. Licensing and bonding of mortgage brokers and lenders, along with establishing a clear mechanism for enforcing the rights of borrowers and investors for violations of legal and contractual obligations, would be beneficial to the securitization market. However, I believe that there are superior alternatives to the Administration's recommendation of retention of 5 percent of credit risk to achieve this goal. I would recommend an origination certificate that provides a direct guarantee of the obligations of the originator to the investors and the obligation of the originator to the borrowers coupled with penalties for violations even in good markets and requires evidence of financial backing. This would be a more effective solution. If the flaws that led to the current crisis are addressed by Government and by industry, securitization can once again make valuable contributions to our economy. I look forward to your questions. Thank you. " CHRG-110shrg50420--286 Mr. Nardelli," I think the pricing of the credit is really driven by the markets today, just like our pricing is driven--we can set a price. The consumer dictates the price. And the same is true in the credit market, sir. When you go back to the industry, when it was 17-plus million, you quickly see where the credit was and the ability to make credit accessible to a much lower FICO score that allow consumers to really step into these vehicles along with the lease program. Twenty percent of our volume I think across the board was lease programs. Senator Reed. Thank you. " CHRG-111shrg57322--556 Mr. Swenson," Yes. Senator Levin. And the first three items there, residential prime, residential credit, and CDO-CLO, those were mainly from the old inventory, I gather, and they continued to lose money. That was the long that had been previously dragging the company down. And if you look at what was lost on that side of it, residential prime, residential credit, CDO, when you add those three together, those losses come to $2.9 billion. Does that look about right to you? " CHRG-111hhrg58044--315 Chairman Gutierrez," The time of the gentleman has expired. " Mr. Rukavina," --that only those medical accounts that have been paid or fully settled be removed from a credit report within a certain period of time. [The prepared statement of Mr. Rukavina can be found on page 137 of the appendix.] " CHRG-111hhrg51698--303 Mr. Short," Thank you. Chairman Peterson, Ranking Member Lucas, I am Johnathan Short, Senior Vice President and General Counsel with IntercontinentalExchange or ICE. We are grateful for the opportunity to provide comments on the discussion draft of the Derivatives Markets Transparency and Accountability Act, and I fully support the goals of the Act to bring transparency and accountability to commodity markets. As the owner of regulated exchanges and clearinghouses in the United States, the United Kingdom and Canada, ICE has committed to facilitating global regulatory cooperation to ensure that regulatory best practices are adopted around the world. As the global nature of this financial crisis aptly illustrates, systemic market problems cannot be solved unilaterally, and solutions will require close cooperation between governments of major developed nations and a willingness on the part of those governments to implement the best financial market practices, regardless of their source of origin. Combined with commitment to open markets, such an approach will be the best way to achieve the goals of the DMTAA. Against this backdrop, we would offer brief thoughts on three sections of the Act: section 3, foreign boards of trade; section 6, trading limits to prevent excessive speculation; and section 16, limitation on the ability to purchase credit default swaps. Please note that our views on specific provisions of the Act should not be misconstrued as opposition to the Act as a whole, or opposition to the important steps that this Committee has taken to restore confidence in our financial markets. Beginning with section 3 on foreign boards of trade, ICE is generally supportive of this provision as it codifies existing obligations that ICE Futures Europe has been complying with since late last year, including implementation of position limits and accountability for DCM link contracts. And, for the first time in a European exchange regulation, the generation of large trader reporting to assist the CFTC in its markets surveillance efforts. However, section 3 of the Act contains one provision that would inappropriately discriminate against foreign exchanges and the competition that they bring to bear. Unlike the requirements applicable to domestic exchanges, section 3 requires that foreign exchanges adopt position limits taking into consideration the relative sizes of respective markets. This provision would hamper competition between exchanges and would effectively prevent foreign exchanges from attaining sufficient market liquidity to offer the type of trading markets necessary to compete with domestic exchanges as all competitors would, by definition, start with little or no market share. Domestic exchanges could ultimately be impacted as well by this provision if foreign governments adopt similar provisions in their laws. Considering the significant benefits that competition has brought to the marketplace and the need for international regulatory cooperation, we would respectfully request that this provision of the Act be modified, and would note that if the goal of the provision is to prevent multiplication of positions across numerous exchanges, the same goal could be achieved through requiring market participants to liquidate positions should they exceed an aggregate limit observed by the CFTC. Turning to section 6 of the Act, ICE's subsidiary, ICE Futures U.S., formerly the New York Board of Trade, is a designated contract market regulated by the CFTC. Among the products it lists for trading are three international soft commodity contracts: coffee, wool, sugar and cocoa; and it is the preeminent market for price discovery in these commodities. None of these commodities are grown in the United States or are subject to any domestic price support programs, unlike domestic commodities'; and all of these commodities are also traded on established exchanges in London, Brazil and the Far East. Section 6 fails to distinguish between the international agricultural commodities and domestically grown agricultural commodities that have traditionally been the focus of the Committee's oversight. Section 6 would require the CFTC, rather than ICE Futures U.S., to set position limits with respect to these international markets, and would replace ICE Futures' strong market expertise in these areas to the detriment of both the exchange and the broader markets, potentially shifting trading in these commodities to foreign markets that are not subject to CFTC jurisdiction. Finally, turning to section 16 of the Act that prohibits trading and credit default swaps without ownership and the underlying obligation. As with all trading markets, hedgers must be able to transact with another party willing to buy their risk for a price. Section 16 would likely end the CDS market in the United States due to the inability of hedgers to find counterparties legally able to buy their risk, and could prove problematic for the trading of CDS indices in which parties would apparently have to own all of the underlying bonds to trade an index. This would be counterproductive, as transparent and stable CDS markets are important for the recovery of broader financial markets. Many of the problems that have been identified in the CDS market relate to the lack of transparency in markets and outsize risks undertaken by financial entities, and we believe that these issues can be addressed through central counterparty clearing. ICE is proud to be working towards establishing ICE U.S. Trust to clear these products. In conclusion, ICE strongly supports the goals of the Act and will continue to work cooperatively with this Committee to find solutions that promote the best marketplace possible. [The prepared statement of Mr. Short follows:] Prepared Statement of Johnathan H. Short, Senior Vice President and General Counsel, IntercontinentalExchange, Inc., Atlanta, GAIntroduction Chairman Peterson, Ranking Member Lucas, I am Johnathan Short, Senior Vice President and General Counsel of IntercontinentalExchange, Inc., or ``ICE.'' We are grateful for the opportunity to provide comments on the ``discussion draft'' of the Derivatives Markets Transparency and Accountability Act (DMTAA). ICE fully supports the goal of the DMTAA to ``bring transparency and accountability to commodity markets.'' Over the past decade, we have worked with regulators both in the United States and abroad to achieve this end and appreciate the opportunity to work on additional improvements. As background, ICE operates three regulated futures exchanges: ICE Futures Europe, formerly known as the ``International Petroleum Exchange,'' is regulated by the U.K. Financial Services Authority (FSA). ICE Futures U.S., previously known as ``The Board of Trade of the City of New York (NYBOT)'' and the New York Clearing Corporation are both regulated by the CFTC. ICE Futures Canada, which was previously called the Winnipeg Commodity Exchange, is regulated the Manitoba Securities Commission. In addition, ICE operates an over-the-counter (OTC) energy platform as exempt commercial market, as defined by the Commodity Exchange Act. On these exchanges, ICE offers futures and options contracts on energy products (including the benchmark Brent and WTI contracts), agricultural commodities, currencies and equity indexes. ICE has worked to provide transparency to a varied array of markets. For example, ICE brought transparency to OTC energy markets nearly a decade ago, with a digital platform that transformed the marketplace from an opaque, telephone-based network of brokerages to a global market with real-time prices on electronic trading screens. In its 2007 State of the Markets Report, Federal Energy Regulatory Commission (FERC) observed that ICE ``provides the clearest view we have into bilateral spot markets.'' \1\--------------------------------------------------------------------------- \1\ Federal Energy Regulatory Commission, 2007 State of the Markets Report, pg. 9 (Issued, March 20, 2008).--------------------------------------------------------------------------- In 2002, in response to the credit and counterparty risk crisis that were then gripping the energy markets, we introduced clearing into the OTC energy markets. Cleared contracts now account for more than 90 percent of ICE's OTC business. Believing that centralized clearing is an essential next step in stabilizing the credit derivatives market, since last summer ICE has been working with the Federal Reserve System, the New York Banking Department and a number of industry participants to develop a clearing solution for credit default swaps (CDS). Last May, as part of the farm bill reauthorization, Congress provided the CFTC with greater oversight of electronic OTC markets, or Exempt Commercial Markets. The new law provides legal and regulatory parity between fully regulated futures exchanges and OTC contracts that serve a significant price discovery function,\2\ while also recognizing and preserving the role of OTC markets in providing innovation and customization. ICE supported this legislation, and we remain grateful for this Committee's leadership during that debate.--------------------------------------------------------------------------- \2\ This provision of the farm bill is commonly referred to as the ``Closing the Enron Loophole Act.''--------------------------------------------------------------------------- Because ICE operates markets in both domestic and foreign jurisdictions, ICE is keenly aware of the global nature of most commodity and financial derivative markets. Furthermore, ICE is committed to facilitating global regulatory cooperation and the implementation of best practices in financial markets around the world. As the global nature of this financial crisis illustrates, systemic market problems cannot be solved independently, and solutions will require both close coordination and cooperation between governments of major developed nations and a willingness to implement best practices regardless of their source of origin. Combined with a commitment to open markets, such an approach will be the best way forward toward solving the problems that have impacted economies around the world. We offer our comments on several provisions in the bill in the spirit of finding solutions that will achieve the stated purpose of improving transparency and accountability in commodity markets.Section 3--Foreign Boards of Trade Earlier last month, the G30's Working Group on Financial Reform, led by Chairman Paul Volcker, published its Framework for Financial Stability. Core recommendation two states, ``The quality and effectiveness of prudential regulation and supervision must be improved. This will require better-resourced prudential regulators and central banks operating within structures that afford much higher levels of national and international policy coordination.'' Recommendation 6b, on regulatory structure, states, ``In all cases, countries should explicitly reaffirm the insulation of national regulatory authorities from political and market pressures and reassess the need for improving the quality and adequacy of resources available to such authorities.'' By supporting coordination and information sharing among international regulators, the foreign board of trade provision in the DMTAA, advances the G30's recommendations. We are concerned; however, that one aspect of that provision could limit competition between domestic and foreign exchanges and ultimately threaten cooperation between domestic and foreign regulators, and indeed domestic and foreign governments, in implementing uniform standards to improve markets. Since 2006, ICE has worked with the United Kingdom's Financial Services Authority to provide the CFTC with visibility into markets traded on its foreign board of trade to allow the CFTC to properly surveil domestic regulated markets. On June 17, 2008, the CFTC revised the conditions under which ICE Futures Europe operates in the United States by amending the ``no-action relief letter'' that permits that exchange to have direct access to U.S. customers for its WTI Crude Oil Futures Contract. The amended letter conditioned ICE Futures Europe's direct screen based access on the adoption of U.S. equivalent position limits and accountability levels, together with reporting obligations, related to contracts that are linked to the price of a U.S. designated contract market price. Since October, ICE Futures Europe has been complying with the revised No Action letter. Section 3 of the DMTAA essentially codifies the conditions set forth in the CFTC's revised No Action letter for ICE Futures Europe, with one important exception. Unlike the requirements applicable to domestic exchanges, section 3 requires foreign exchanges to adopt position limits for the affected contract taking ``into consideration the relative sizes of the respective markets''. This provision discriminates against foreign exchanges, and would effectively prevent them from attaining sufficient market liquidity to compete with domestic exchanges as all competitors would by definition start out with little or no market share. In addition, domestic exchanges could be impacted through the adoption of similar provisions of law in foreign countries which have a larger relative share of the underlying commodity market. In recent years, the only effective competition in the futures industry has come from foreign exchanges and exempt commercial markets. That competition has led U.S. exchanges to transition markets to transparent electronic trading, with full audit trails and improved risk management through straight through processing. It has also resulted in more efficient markets bringing about many benefits for market participants such as lower trading costs and tighter bid/ask spreads. With one exchange in control of more than 97 percent of U.S. futures market, competition is more important than ever. Requiring foreign markets to set position limits according to respective market size would effectively bar foreign exchanges from competing in the U.S., would likely be viewed was extraterritorial regulation by foreign market regulators, and would be inconsistent with the higher level of international policy coordination contemplated by the G30 policy recommendations. ICE respectfully requests that this particular provision of section 3 be reconsidered for the broader policy goals that are sought to be achieved by the G30 policy recommendations and in recognition of the fact that no single piece of legislation adopted here or elsewhere will achieve its ends unless appropriate standards are adopted on an international basis.Section 6--Trading Limits To Prevent Excessive Speculation ICE's U.S. subsidiary, ICE Futures U.S. (formerly the New York Board of Trade) is a designated contract market regulated by the CFTC. Among the products it lists for trading are three international soft commodities--coffee, world sugar and cocoa--and it is the pre-eminent market for price discovery of these commodities. None of these commodities is grown in the United States or is subject to domestic price support programs. Moreover, none of them was the subject of hearings last year conducted by Congressional Committees or reviews by the CFTC into the rise and fall of certain commodity prices. Because they are liquid contracts traded on a designated contract market, our futures and options contracts in these commodities have been subject to position accountability levels and spot month position limits that have been established and administered by the Exchange for more than a decade without incident. Under the terms of the standardized futures contracts, ICE Futures U.S. also regulates physical delivery of those three international commodities from ports or warehouses located in more than two dozen foreign countries around the world. Section 6 of the proposed legislation fails to distinguish between ICE's international agricultural contracts and the domestically-grown agricultural commodities that we believe were the bill's intended subjects. Specifically, the legislation would require the CFTC to set position limits on the number of futures and option contracts that a person could hold in any one futures month of a commodity, in all combined futures months of a commodity, and in the spot month. In contrast, ICE Futures U.S. sets limits for its coffee, sugar and cocoa contracts based on its extensive experience with these markets. In addition, the proposed legislation would amend the Commodity Exchange Act core principles applicable to designated contract markets like ICE Futures U.S. by eliminating the availability of ``position accountability'' levels for speculators in international agricultural commodities. As noted previously, ICE Futures U.S. has set and administered position accountability levels in its internationally-based products for over a decade. For example, through its market oversight, ICE Futures U.S. has been able to respond to market conditions and the needs of its users in a flexible manner, while maintaining transparent and liquid markets relied upon throughout the world. This provision, if implemented, would replace ICE Futures U.S.'s strong market surveillance role with an inflexible regime that would be established, and possibly administered, by the CFTC. This could very well drive business to London, Brazil and the Far East where these products already trade on established futures markets. We do not believe this was the drafters' intent.Section 6--Limitations on index traders Section 6 defines bona fide hedging in a way that would prohibit index traders from taking a position in excess of position limits. This would be a significant change in market structure and will have an immediate and deleterious impact. A recent market study performed by Informa examined the impact of index funds on market volatility. The study employed both Granger causality and vector auto-regression tests and determined that there was no link between index funds and market volatility. Greatly reducing the participation of index funds in the market would be disadvantageous to the market at-large and would most likely only benefit the very largest participants in a given market. In a soft commodities market (e.g., coffee, sugar or cocoa), the removal of this additional liquidity could potentially enable a single large entity or a small group of entities to wield considerable influence on the market dynamics. Section 9 requires the CFTC to study the impact of commodity ``fungibility'' and whether there should be ``aggregate'' position limits for similar agriculture or energy contracts traded on DCMs, DTEFs, 2(g) and 2(h) markets. Sec. 10 requires a GAO study of international regulation of energy commodity markets. Both reports are due in a year. ICE supports these studies without reservation, and we believe this legislation would be improved if it were informed by equally thorough reports on the issues we have discussed today.Section 16--Limitation on Ability To Purchase Credit Default Swaps Section 16 of the bill would prohibit trading in credit default swaps without ownership of the underlying reference obligation. This provision is problematic on several levels. First, CDS perform an important market function in allowing parties to hedge credit risk. Section 16 is titled ``Limitation on Eligibility to Purchase a Credit Default Swap.'' However, the language in subsection (a) prohibits parties from ``entering into a credit default swap'' unless they own the underlying bonds. As with all trading markets, another party must be willing to assume the hedger's risk; therefore, section 16 would likely end the CDS market in the United States due to the inability of hedgers to find counterparties legally able to ``buy their risk''. This would be counterproductive, as a transparent and stable CDS market is important for the recovery of financial markets. Furthermore, not all credit risk has a tailored credit default swap. Section 16 would prohibit parties from hedging default exposure by purchasing credit default indices, unless the party owned every underlying bond in the index. Second, ICE believes that the goals of transparency and mitigation of counterparty credit risk and systemic risk can be achieved through central clearing of CDS and through resulting public and regulatory transparency. Section 16 would run counter to this goal as it would impair the liquidity needed to efficiently manage risk within a clearinghouse in the event of a default or similar event. ICE respectfully requests that the Committee consider eliminating this provision of the draft bill. During the financial crisis, as cash markets evaporated, and markets for commercial paper, corporate bonds and other debt instruments dried up, the CDS market has remained liquid, offering lenders and investors a way to hedge risk and--just as important--a market-based, early-warning price discovery function. Broader availability of credit protection can encourage sovereign and corporate lending. As lenders and investors consider ways to improve credit risk evaluations, CDS spreads have proven to be more reliable indicators of an institution's financial health than credit agency ratings. Finally, on the note of global cooperation, last week in Davos, E.U. Financial Services Commissioner Charlie McCreevy said he would not support a ban on trading credit default swaps unless the party held a position in the underlying bonds. Prohibiting this trade in the United States will almost certainly lead to a wholesale migration of the CDS marketplace overseas, outside the reach of U.S. regulators and this Committee. We do not believe that is the intent of this legislation.Conclusion ICE is a strong proponent of open and competitive derivatives markets, and of appropriate regulatory oversight of those markets. As an operator of global futures and OTC markets, and as a publicly-held company, we understand the essential role of trust and confidence in our markets. To that end, we are pleased to work with Congress to address the challenges presented by derivatives markets, and we will continue to work cooperatively for solutions that promote the best marketplace possible. Mr. Chairman, thank you for the opportunity to share our views with you. I am happy to answer any questions you may have. " FinancialCrisisReport--86 In June 2007, WaMu decided to discontinue Long Beach as a separate entity, and instead placed its subprime lending operations in a new WaMu division called “Wholesale Specialty Lending.” That division continued to purchase subprime loans and issue subprime securitizations. Some months later, an internal WaMu review assessed “the effectiveness of the action plans developed and implemented by Home Loans to address” the first payment default problem in the Wholesale Specialty Lending division. 255 After reviewing 187 FPD loans from November 2006 through March 2007, the review found: “The overall system of credit risk management activities and process has major weaknesses resulting in unacceptable level of credit risk. Exposure is considerable and immediate corrective action is essential in order to limit or avoid considerable losses, reputation damage, or financial statement errors.” 256 In particular, the review found: “Ineffectiveness of fraud detection tools – 132 of the 187 (71%) files were reviewed … for fraud. [The review] confirmed fraud on 115 [and 17 were] … ‘highly suspect’. ... Credit weakness and underwriting deficiencies is a repeat finding …. 80 of the 112 (71%) stated income loans were identified for lack of reasonableness of income[.] 133 (71%) had credit evaluation or loan decision errors …. 58 (31%) had appraisal discrepancies or issues that raised concerns that the value was not supported.” 257 July 2007 was a critical moment not only for WaMu, but also for the broader market for mortgage securities. In that month, Moody’s and S&P downgraded the ratings of hundreds of RMBS and CDO securities, including 40 Long Beach subprime securities. 258 The mass downgrades caused many investors to immediately stop buying subprime RMBS securities, and the securities plummeted in value. Wall Street firms were increasingly unable to find investors for new subprime RMBS securitizations. In August 2007, WaMu’s internal audit department released a lengthy audit report criticizing Long Beach’s poor loan origination and underwriting practices. 259 By that time, Long Beach had been rebranded as WaMu’s Wholesale Specialty Lending division, the subprime market had collapsed, and subprime loans were no longer marketable. The audit report nevertheless provided a detailed and negative review of its operations: 255 9/28/2007 “Wholesale Specialty Lending-FPD,” WaMu Corporate Credit Review, JPM_WM04013925, Hearing Exhibit 4/13-21. 256 Id. at 2. 257 Id. at 3. 258 7/10/2007-7/12/2007 excerpts from Standard & Poor’s and Moody’s Downgrades, Hearing Exhibit 4/23-99. 259 8/20/2007 “Long Beach Mortgage Loan Origination & Underwriting,” WaMu audit report, JPM_WM02548939, Hearing Exhibit 4/13-19. “[T]he overall system of risk management and internal controls has deficiencies related to multiple, critical origination and underwriting processes .… These deficiencies require immediate effective corrective action to limit continued exposure to losses. … Repeat Issue – Underwriting guidelines established to mitigate the risk of unsound underwriting decisions are not always followed …. Improvements in controls designed to ensure adherence to Exception Oversight Policy and Procedures is required …. [A]ccurate reporting and tracking of exceptions to policy does not exist.” 260 CHRG-111shrg50815--81 Mr. Clayton," I don't think that 3-year-old daughter actually got a card, nor could they be obligated to pay under that card, so--look, marketing, people get letters because they are on some other lists. It doesn't mean they are going to get a credit card. And so to be real clear, I doubt--Senator, please feel free to correct me--I mean, it is a solicitation and so it is nothing more than an advertisement to apply. Credit card companies look carefully at trying to cultivate relationships with 18-year-olds, 20-year-olds, 22-year-olds, 24-year-olds, because they recognize they are in for the long haul. They take that responsibility seriously, and in fact, they take special care. They make sure that their minimum limits are actually--their credit limits are low, and they start off typically with a $500 credit limit and it doesn't grow that quickly. And they work with care to make sure they--and monitor the card account to make sure they don't get into trouble. One of the things that gets lost in this debate is that, in fact, students perform well in their use of credit cards. There are lots of different studies and different numbers. The numbers that we see are that they perform as well as or if not better than the general population, and they have average balances that are much lower than the general population. So as a practical matter, the vast majority of students are using their cards responsibly and well. Do people get into trouble? Absolutely. Should we be sensitive to that and figure out better ways to address that? I think we would be willing to work with you and figure out how to best do that. Senator Tester. And I appreciate that because I think it does need to be done. The fact is, and I will go back to Senator Brown's comments because he brought it up with the Web site from Ohio State. If, in fact, this is true, then why do we see consumer debt going up for kids, going through the roof? And quite frankly, if we are paying tuition with credit cards, we are heading way, way, way down the wrong road there. " CHRG-111shrg50815--5 STATEMENT OF SENATOR AKAKA Senator Akaka. Yes. Thank you very much. I appreciate the Chairman holding this hearing. Too many in our country are burdened by significant credit card debt. Not enough has been done to protect consumers and ensure they are able to properly manage their credit burden. We must do more to educate, protect, and empower consumers. Three Congresses ago, or the 108th Congress, I advocated for enactment of my Credit Card Minimum Payment Warning Act. I developed the legislation with Senators at that time, Senators Sarbanes, Durbin, Schumer, and Leahy. We attempted to attach the bill as an amendment to improve the flawed minimum payment warning in the Bankruptcy Abuse Prevention and Consumer Protection Act. Unfortunately, our amendment was defeated. My legislation, which I will be reintroducing shortly, requires companies to inform consumers how many years and months it will take to repay their entire balance if they make only minimum payments. The total cost of interest and principal if the consumer pays only the minimum payment would also have to be disclosed. These provisions will make individuals much more aware of the true costs of credit card debt. The bill also requires that credit card companies provide useful information so that people can develop strategies to free themselves of credit card debt. Consumers would have to be provided with the amount they need to pay to eliminate their outstanding balance within 36 months. My legislation also addresses the related issue of credit counseling. We must ensure that people who seek help in dealing with complex financial issues, such as debt management, are able to locate the assistance they need. Credit card billing statements should include contact information for reputable credit counseling services. More working families are trying to survive financially and meet their financial obligations. They often seek out help from credit counselors to better manage their debt burdens. It is extremely troubling that unscrupulous credit counselors exploit for their own personal profit individuals who are trying to locate the assistance they need. My legislation establishes quality standards for credit counseling agencies and ensures that consumers would be referred to trustworthy credit counselors. As financial pressures increase for working families, credit counseling becomes even more important. As we work to reform the regulatory structure of financial services, it is essential that we establish credit counseling standards and increase regulatory oversight over this industry. Mr. Chairman, I appreciate your inclusion of this in your bill, of a provision that mirrors the minimum payment warning provisions in my bill. Thank you very much, Mr. Chairman. Senator Johnson. Thank you, Senator Akaka. Senator Menendez, do you have a very brief statement to make? CHRG-111hhrg51592--136 Mr. Sherman," Thank you, Mr. Chairman. Responding in part to the gentleman from Alabama, I think it's important not who pays the credit rating agency, but who selects the credit rating agency. And I'll give you a baseball analysis on that. Imagine a baseball league in which the league pays the umpires, but the home team gets to select anybody they want to be the umpire. That's going to be a home team that's going to win a lot of games. In contrast, imagine a baseball league where the home team has to give $100 to the umpire, each umpire, but the league sends out the umpires. Those are going to be umpires who are answerable to the league, whose livelihood depends upon the league thinking they're doing a good job. As long as issuers are selecting the credit rating agency, then the way to be successful as a credit rating agency is to make the issuers happy, and then conceal from the public that the way to be successful is to make the issuers happy. It's who selects, not who pays. Now, one approach we could have to all this is to try to make the credit rating more reliable. The other, and I think our first witness kind of took this approach--I'm sure I'm over-simplifying--we could just tell everybody how unreliable these credit ratings are, and tell them not to rely upon them, or only as a first step. Now, Vanguard has the advantage of hiring, what did you say, 30, 40 different credit analysts. I won't ask you whether it's 30 or 40. Investors ought to be allowed to invest directly in debt instruments, without hiring a team of 40 people. They should be able to rely on the credit rating. And even--and I have all my money at Vanguard. But when I even--and so I'm relying on your analysts, but not entirely, because I have to compare your funds to other funds that tell me they get better yields. But then I look, and I see which fund invests more safely. Well, how can I determine that? I could rely upon your name, although there are some big names on Wall Street that have tanked recently. I don't know which names are good and which aren't. Or, I can rely upon the fact that your bond funds are mostly AA and partially AAA, and somebody else's high-yield fund--as a matter of fact, that's what distinguishes your high-yield fund from the lower-yield funds. Professor, you said if somebody gathers information, analyzes it, and expresses their opinion, that would be protected by the First Amendment. I would add, that's what my doctor does, but boy, if he's wrong, I'm going to sue him. But more to the point, that's what accountants do and that's what legal opinions do, in offering materials, private placement memorandums, SEC regulations. I think I'm the only CPA up here. And what does, when you look in the offering materials, or financial statements, and then there are two paragraphs, usually, written by the auditors. They say, ``In our opinion, the attached financial statements accurately reflect, according to generally accepted accounting principles.'' So I'll ask you to respond for the record, how the credit rating agency is different from the accounting firm, both in public offerings and in private placement memoranda, but also, you have, if there's a tax advantaged investment, you usually have an opinion letter from a tax counsel, saying, ``Here are what the tax consequences are.'' I have been the auditor. I have been the tax counsel. And in every case, I knew I would get sued if I was wrong. Otherwise, you would be--well, I would have--my professionalism would have restrained me, but I have colleagues that would have issued just about any kind of opinion. What I'll ask you to respond to orally--those other questions are for the rating--is, is there any constitutional bar to us saying, certain credit rating agencies will register with the SEC, and as part of that registration, should they choose to register, they have to waive the right not to be sued for their negligence? " CHRG-111hhrg48873--285 Mr. Meeks," Thank you, Mr. Chairman. I want to thank all three of you for your testimony today. I think it has been very enlightening for me. I want to just touch on a couple of things. First, one of Mr. Ackerman's questions was about credit default swaps. Do you think that we in Congress and you should work on some further regulations, specific regulations, in regards to credit default swaps? And if we do that, what effect do you think it will have on the global financial system, and how can we work that out in that regard? " CHRG-110hhrg46596--223 Mr. Kashkari," Well, ultimately, it is the credit cards, and ultimately it is the borrowers who owe on the credit cards, or on auto loans. Similarly, these are consumer credit vehicles to start with. But what the Federal Reserve and Treasury are focused on is these are historically very low credit risk. They are not being priced where they are today because of credit risk; they are being priced where they are today because of illiquidity in the system. " CHRG-111hhrg54872--36 The Chairman," Next, we will hear from Janice Bowdler, who is the senior policy analyst at the National Council of La Raza. STATEMENT OF JANIS BOWDLER, DEPUTY DIRECTOR, WEALTH-BUILDING POLICY PROJECT, NATIONAL COUNCIL OF LA RAZA (NCLR) Ms. Bowdler. Good morning. Thank you. I would like to thank Chairman Frank and Ranking Member Bachus for inviting NCLR to share perspective on this issue. Latino families have been particularly hard hit by the implosion of our credit markets. Lax oversight allowed deceptive practices to run rampant, driving Latino families into risky products and ultimately cyclical debt. In fact, Federal regulators routinely missed opportunities to correct the worst practices. Congress must plug holes in a broken financial system that allowed household wealth to evaporate and debt to skyrocket. Today, I will describe the chief ways our current regulatory system falls short, and I will follow with a few comments on the CFPA. Most Americans share a fundamental goal of achieving economic security they can share with their children. To do so, they rely on financial products--mortgages, credit cards, car loans, insurance, and retirement accounts. Unfortunately, market forces have created real barriers to accessing the most favorable products, even when families are well-qualified. Subprime creditors frequently targeted minority communities as fertile ground for expansion. Subprime lending often served as a replacement of prime credit, rather than a complement. With much of the damage coming at the hands of underregulated entities, gaming of the system became widespread. Despite the evidence, Federal regulators failed to act. This inaction hurt the Latino community in three distinct ways. Access to prime products was restricted, even when borrowers had good credit and high incomes. This most often occurred because short-term profits were prioritized over long-term gains. Lenders actually steered borrowers into costly and risky loans, because that is what earned the highest profits. Disparate impact trends were not acted upon. Numerous reports have documented this trend. In fact, a study conducted by HUD in 2000 found that high-income African Americans, living in predominantly black neighborhoods, were 3 times more likely to receive subprime home loans than low-income white borrowers. Regulators failed to act, even when Federal reports made the case. And shopping for credit is nearly impossible. Financial products have become increasingly complex, and many consumers lack reliable information. Many chose to pay a broker to help them shop. Meanwhile, those brokers have little or no legal or ethical obligation to actually work on behalf of the borrower. Regulators dragged their feet on reforms that could have improved shopping opportunities. If our goal is to truly avoid the bad outcomes in the future, the high rates of foreclosure and household debt, little or no savings and the erosion of wealth, we have to change the Federal oversight system. Lawmakers must ensure that borrowers have the opportunity to bank and borrow at fair and affordable terms. We need greater accountability and the ability to spot damaging trends before they escalate. Some have argued that it is the borrower's responsibility to look out for deception. However, it is unreasonable to expect the average family to regulate the market and in effect to do what the Federal Reserve did not. The proposed CFPA is a strong vehicle that could plug the gaps in our regulatory scheme. In particular, we commend the committee for including enforcement of fair lending laws in the mission of the agency. This, along with the creation of the Office of Fair Lending and Equal Opportunity, will ensure that the agency also investigates harmful trends in minority communities. This is a critical addition that will help Latino families. We also applaud the committee for granting the CFPA strong rule-writing authority. This capability is fundamental to achieving its mission. Also, we were pleased to see that stronger laws are not preempted. This will ensure that no one loses protection as a result of CFPA action. As the committee moves forward, these provisions should not be weakened. And I will close just by offering a few recommendations of where we think it could be strengthened. A major goal of CFPA should be to improve access to simple prime products. Obtaining the most favorable credit terms for which you qualify is important to building wealth. This includes fostering product innovation to meet the needs of underserved communities. We need to eliminate loopholes for those that broker financing, and for credit bureaus. Real estate agents, brokers, auto dealers, and credit bureaus should not escape greater accountability. And we need to reinstate a community-level assessment. Without it, good products may be developed but will remain unavailable in entire neighborhoods. Including CRA in the CFPA will give the agency the authority necessary to make such an assessment. Thank you. And I would be happy to answer any questions. [The prepared statement of Ms. Bowdler can be found on page 66 of the appendix.] Ms. Waters. [presiding] Ms. Burger is recognized for 5 minutes. STATEMENT OF ANNA BURGER, SECRETARY-TREASURER, SERVICE EMPLOYEES INTERNATIONAL UNION (SEIU) Ms. Burger. On behalf of the 2.1 million members of SEIU and as a coalition member of the Americans for Financial Reform, I want to thank Chairman Frank, Ranking Member Bachus, and the committee members for their continued work to reform our broken financial system. It has been a year since the financial world collapsed, showing us that the action of a few greedy players on Wall Street can take down the entire global economy. As we continue to dig out of this crisis, we have an historic opportunity and a responsibility to reform the causes of our continued financial instability, and protect consumers from harmful and often predatory practices employed by banks to rake in billions and drive consumers into debt. The nurses, the childcare providers, janitors, and other members of SEIU continue to experience the devastating effects of the financial crisis firsthand. Our members and their families are losing their jobs, homes, health care coverage, and retirement savings. As State and local governments face record budget crises, public employees are losing their jobs and communities are losing vital services. And we see companies forced to shut their doors as banks refuse to expand lending and call on lines of credit. At the same time, banks and credit card companies continue to raise fees and interest rates and refuse to modify mortgages and other loans. We know the cause of our current economic crisis. Wall Street, big banks, and corporate CEOs created exotic financial deals, and took on too much risk and debt in search of outrageous bonuses, fees, and unsustainable returns. The deals collapsed and taxpayers stepped in to bail them out. According to a recent report released by SEIU, once all crisis-related programs are factored in, taxpayers will be on the hook for up to $17.9 trillion. And I would like to submit the report for the record. The proliferation of inappropriate and unsustainable lending practices that has sent our economy into a tailspin could and should have been prevented. The regulators' failure to act, despite abundance of evidence of the need, highlights the inadequacies of our current regulatory system in which none of the many financial regulators regard consumer protection as a priority. We strongly support the creation of a single Consumer Financial Protection Agency to consolidate authority in one place, with the sole mission of watching out for consumers across all financial services. I want to thank Chairman Frank for his work to strengthen the Proposed Consumer Financial Protection Agency language, particularly the strong whistle-blower protections. We believe to be successful, the CFPA legislation must include a scope that includes all consumer financial products and services; sovereign rulemaking and primary enforcement authority; independent examination authority; Federal rules that function as a floor, not a ceiling; the Community and Reinvestment Act funding that is stable and does not undermine the agency's independence from the industry; and strong whistle-blower and compensation protections. We believe independence, consolidated authority, and adequate power to stop unfair, deceptive, and abusive practices are key features to enable the CFPA to serve as a building block of comprehensive financial reforms. Over the past year, we have also heard directly from frontline financial service workers about their working conditions and industry practices. We know from our conversations that existing industry practices incentivize frontline financial workers to push unneeded and often harmful financial products on consumers. We need to ban the use of commissions and quotas that incentivize rank-and-file personnel to act against the interest of consumers in order to make ends meet or simply keep their job. The CFPA is an agency that can create this industry change. Imagine if these workers were able to speak out about practices they thought were deceptive and hurting consumers, the mortgage broker forced to meet a certain quota of subprime mortgages, or the credit card call center worker forced to encourage Americans to take on debt that they cannot afford and then they threaten and harass them when they can no longer make their payments, or the personal banker forced to open up accounts of people without their knowledge. Including protection and a voice for bank workers will help rebuild our economy today and ensure our financial systems remain stable in the future. Thank you for the opportunity to speak this morning. The American people are counting on this committee to hold financial firms accountable and put in place regulations that prevent crises in the future. Thank you. Ms. Waters. Thank you very much. [The prepared statement of Ms. Burger can be found on page 74 of the appendix.] Ms. Waters. I will recognize myself for 5 minutes. And I would like to address a question to Mr. David C. John, senior research follow, Thomas A. Roe Institute for Economic Policy Studies, The Heritage Foundation. I thank you for participating and for the recommendation that you have given, an alternative to the Consumer Financial Protection Agency. You speak of the consumer protection agency as a huge bureaucracy that would be set up, that would harm consumers, rather than help consumers, and you talk about your council as a better way to approach this with lots of coordination and outside input. It sounds as if you are kind of rearranging the chairs. Basically, what you want to do is leave the same regulatory agencies in place who had responsibility for consumer protection but did not exercise that responsibility. Why should the American public trust that, given this meltdown that we have had, this crisis that has been created, that the same people who had the responsibility are now going to see the light and they are going to do a better job than starting anew with an agency whose direct responsibility is consumer protection? " CHRG-111shrg51395--130 PREPARED STATEMENT OF THOMAS DOE Chief Executive Officer, Municipal Market Advisors March 10, 2009Introduction Chairman Dodd, Senator Shelby and Committee Members: It is a distinct pleasure that I come before you today to share my perspective on the U.S. municipal bond industry. I am Thomas Doe, founder and CEO of Municipal Market Advisors, that for the past 15 years has been the leading independent research and data provider to the industry. In addition from 2003 to 2005, I served as a public member of the Municipal Securities Rulemaking Board (MSRB), the selfregulatory organization (SRO) of the industry established by Congress in 1975.The Market There are nearly 65,000 issuers in the municipal market that are predominantly states and local governments. Recent figures identify an estimated $2.7 trillion in outstanding municipal debt. This is debt that aids our communities in meeting budgets and financing society's essential needs, whether it is building a hospital, constructing a school, ensuring clean drinking water, or sustaining the safety of America's infrastructure. A distinctive characteristic of the municipal market is that many of those who borrow funds, rural counties and small towns, are only infrequently engaged in the capital markets. As a result, there are many issuers of debt who are inexperienced when entering a transaction, and unable to monitor deals that may involve the movement of interest rates or the value of derivative products.The Growth According to the The Bond Buyer, the industry's trade newspaper, annual municipal bond issuance was $29B in 1975 whereas in 2007 issuance peaked at $430B. In the past 10 years derivatives have proliferated as a standard liability management tool for many local governments. However, because derivatives are not regulated it is exceptionally difficult, if not impossible, to identify the degree of systemic, as well as specific, risk to small towns and counties that have engaged in complex swaps and derivative transactions.Systemic Risk Emerges Municipal issuers themselves sought to reduce their borrowing costs by selling bonds with a floating rate of interest, such as auction-rate securities. Because state and local governments do not themselves have revenues that vary greatly with interest rates, these issuers employed interest rate swaps to hedge their risk. Issuers used the instruments to transform their floating risk for a fixed-rate obligation. A key factor in the growth of the leverage and derivative structures was the prolific use of bond insurance.The Penal Rating Scale Municipal issuers are rated along a conservative ratings scale, resulting in much lower ratings for school districts and states than for private sector financial or insurance companies. Although most state and local governments represent very little default risk to the investor, the penal ratings scale encouraged the use of insurance for both cash and derivatives to distribute products to investors and facilitate issuer borrowing. So instead of requiring more accurate ratings, the municipal industry chose to use bond insurance to enhance an issuer's lower credit rating to that of the higher insurance company's rating. The last 18 months have exposed the risks of this choice when insurance company downgrades, and auction-rate security failures, forced numerous leveraged investors to unwind massive amounts of debt into an illiquid secondary market. The consequence was that issuers of new debt were forced to pay extremely high interest rates and investors were confused by volatile evaluations of their investments.Steps To Improve the Regulatory Context The 34-year era of the municipal industry's self regulation must come to an end. Today, the market would be in a much better place if: First, the regulator were independent of the financial institutions that create the products and facilitate issuers' borrowing. Second, the regulator were integrated into the national regime of regulation. Third, the regulator's reach and authority were extended to all financial tools and participants of the municipal transaction: ratings agencies, insurers, evaluators, and investment and legal advisors for both the cash and swaps transactions. Fourth, the regulator were charged with more aggressively monitoring market data with consumers' interests in mind, both investors and issuers. The good news is that this new era of regulatory oversight can be funded by the MSRB's annual revenue $20-plus million, collected from bond transactions, and can be staffed by the current MSRB policy and administrative infrastructure.Caution I should be clear. The innovations of derivatives and swaps have a useful application and have been beneficial for those for which they are appropriate. However, it is also important that these instruments become transparent and regulated with the same care as the corresponding cash market.Get This Done It is critical to get this right. There is too much at stake. Thank you for asking me to testify today, and I welcome your questions during this session.Municipal Market Advisors Founded in 1995, MMA is the leading independent strategy, research and advisory firm in the municipal bond industry. MMA's intelligent approach to timely issues and analysis of market events has proven invaluable to a wide range of clients. As conditions have become more complex and difficult, MMA's recognized ability to concisely comment on the key issues of the market is of critical importance and value. The firm's independent research, data, market coverage and insight educate and inform without bias or product agenda. Our Clients: Investors, Dealers, Financial Advisors, Issuers and Individuals: MMA's business has been predominantly portfolio managers and dealer firms (with a focus on sales, trading and underwriting). However, in 2007, demand for our services expanded to include issuers, financial advisors, individuals and public finance professionals who have recognized the increased value of accurate and insightful coverage of current historical market conditions. MMA does not advocate on behalf of its clients, we educate on behalf of the market. Washington, DC--Educating and Working With Decision-Makers: MMA's Washington DC office has enabled our firm to provide more direct information to policy makers, regulators, trade associations and the Federal Reserve. MMA's role is that of an educator to provide immediate uncompromised assistance to entities that are actively engaged in working on issues pertaining to the municipal industry. Informing the Media: In 2008, more than 200 publications and media outlets have sought MMA's expertise for definitive comment on the issues confronting the industry. At no other time has accurate market coverage been more valued, and trusted resources considered indispensable. Unbiased information is important for correct representation of market conditions, policy decisions and management of portfolios. Thomas G. Doe, Founder and CEO: Mr. Doe has been an analyst in the municipal industry for 25 years with a consistent focus on pricing data and information flows, investor and issuer behavior, and contextual investing. He has addressed all of the leading groups in the municipal industry, as Mr. Doe's insight, candor and historical context is sought to establish a clear perspective of current conditions affecting investors and issuers in the municipal cash and derivative markets. He has been a featured speaker at numerous industry conferences and has been frequently quoted in industry and national media. Mr. Doe's leadership was recognized when he was named to a 3-year term with the Municipal Securities Rulemaking Board, (MSRB) the regulatory entity of the municipal securities industry in 2002. Mr. Doe received an undergraduate degree from Colgate University in 1980 and a Masters degree from Harvard University in 1984.Background on How the Credit Crisis Has Affected the Municipal Market The municipal market has suffered repeated shocks from the credit crisis since August 2007. In a very primary sense, our sector was, and in many ways continues to be, exposed to the same systemic risks that collapsed the housing and securitization markets and undermined our nation's banks. The deep interconnectedness of the municipal market with the global financial and interest rate markets was unforeseen by most municipal regulators, issuers, investors, advisors, lawyers, and dealer banks; their surprise at, and misunderstanding of, the systemic risks at work has consistently exacerbated problems over the last two years. Further, there is little provision being made at present to create a more resilient and stable market in the future. The initiation of the credit crisis in municipals, as it was elsewhere, began in 2001 and 2002, with the integration of leverage into municipal bond buying strategies. Leveraged investment vehicles, called Tender Option Bond (TOB) programs, borrowed low interest (floating-rate) cash from the tax-exempt money market funds to invest in higher yielding (fixed-rate) municipals. Not only does this strategy capture the simple difference between the high long and low short interest rates (the carry), but also TOB sponsors--which included hedge funds, dealer banks, mutual funds, liquidity providers, and many others--are placing bets on the tax-exempt market's outperformance of carefully selected taxable bonds or swaps via interest rate hedging. However, one of the key conditions for the safe operation of a TOB was not implicit in the municipal market: liquidity. Because TOBs are subject to mark-to-market accounting, margin calls, and periodic adjustments of their leverage, they benefit from a well-traded and accurately priced bond market. A TOB invested in securities with unpredictable or volatile prices will itself provide unpredictable and volatile returns. The municipal bond market, as we have detailed elsewhere in this report, comprises 65,000 potential bond issuers and 1.5 million individual securities, most of which are rated along an overly cautious rating scale that intentionally exaggerates the risks and differences between individual issuers and bonds. Further, municipal issuers have long sold bonds in serial maturities, with a variety of interest rate coupons, call structures, security pledges, etc. And finally, the bulk of municipal investors are households, who either directly or indirectly though a manager, prefer to buy and hold small pieces of multiple bond offerings: these are not active securities trading operations. This context was not conducive for TOBs, but, because their use of leverage they were permitted to purchase municipal bonds at substantially higher prices than other investors were willing to pay, so the primary market rapidly adjusted to their needs. This entailed the pervasive use of AAA-rated bond insurance and bank guaranties (creating the appearance of safe homogeneity) and the facilitation of very large, governmental-oriented bond sales carrying a standardized 5 percent coupon. For the period between 2002 and 2007, these adjustments permitted the near doubling of annual bond issuance (from about $200Bn to about $400Bn), and the amount of par volume municipal bonds outstanding swelled 77 percent from $1.5T in 2001 to $2.7T today. What's more, the rapid growth of TOB (and related strategy) investment--along with a large increase in demand from property casualty insurance companies riding post-9/11 waves of premiums and profitability--allowed municipals to be priced more and more aggressively, fulfilling the TOB investor's aim of outperformance of the taxable bond market and encouraging ever larger allocations to this strategy. At the same time, the interest rates that tax-exempt money market funds were receiving from the TOBs were better than an investor could receive in a regular savings account, and aggressive TOB creation meant a surfeit of product in which the money funds could invest. This attracted more money fund deposits which, along with monetary policy, kept short-term interest rates low. Municipal issuers themselves sought to reduce their borrowing costs by selling long maturity, AAA-insured bonds with a floating rate of interest, including variable-rate demand obligations (VRDOs), which can be purchased by the money market funds, and auction-rate securities, which were largely bought by individuals and corporate cash managers. However, because state and local governments do not themselves receive much revenue that floats with short-term interest rates, these issuers also employed interest rate swaps with these floating-rate bonds in an attempt to exchange their floating-rate liability for a fixed one (but with the addition of increased counterparty exposure to both a bank and the a bond insurer). By these means, issuer interest rate swaps and derivatives became a fundamental, but unregulated part of the municipal industry's standard machinery, and systemic exposure to the financial sector, the bond insurers, and, more importantly, the rating agencies' opinions of the financial sector, and the bond insurers grew rapidly. In addition, our market had become substantially vulnerable to fluctuations in the value of taxable securities: remember that much if not all of the massive investment by TOBs (estimated to have peaked near $500Bn although little was done by the municipal regulators to even tabulate this exposure) was hedged against the performance of Treasuries, LIBOR swaps, or other slightly more muni-centric derivatives. The problems with this arrangement were exposed in August 2007 with the first surge of flight-to-safety buying of Treasury securities on news of worsening damage to the housing sector. Stronger Treasury (and LIBOR) prices created losses in TOB hedges, forcing margin calls that rapidly consumed available cash. In addition, sharp increases in the overnight lending rates pushed floating-rate product credit spreads wider: the source of TOB leverage, loans from the money funds, grew much more expensive, to the point where the money funds were demanding almost as much (or more) interest than the TOBs were receiving from their long-term, fixed-rate municipal position. Some TOBs thus began to liquidate their positions, forcing sales of their fixed-rate bonds into a municipal secondary market that quickly became oversupplied and illiquid. Keep in mind that, up until that point, the TOBs had been purchasing bonds at (and driving market clearing prices and statement evaluations to) higher levels than traditional institutional investors were reasonably willing to pay. Thus, when the TOBs needed to quickly sell their bonds to these same traditional buyers, large price concessions were required. Dealer banks helped soften the effects by acquiring bonds into their own trading inventories, but ultimately market pressures forced municipal bond yields sharply higher (while Treasury yields were moving sharply lower). Higher yields attracted enough demand to stabilize the market by the end of the month, but, through the end of the year, nervous investors repeated this pattern of fast selling/recovery, heightening volatility in prices, and encouraging a steady reduction in TOB investment. For substantially more detail on the daily and weekly evolution of our the market, please see the complete catalog of published MMA research, available to subscribers on our Web site and to Congressional staffs on request. Importantly, market participants had by this time also become increasingly concerned about the future of the bond insurers, who had guaranteed subprime residential mortgage securitizations. Research firms such as MMA and private investors amplified former warnings about these companies. In particular, more cautious corporate cash managers began selling auction-rate securities that had been marketed to them, in part, based on the apparent safety of AAA-rated bond insurance. Once again, dealer banks managing auction-rate programs provided liquidity in the absence of incremental investor demand, but in December 2007, the rating agencies sounded formal warnings about the bond insurers. This precipitated vast selling pressure among auction-rate investors that, in January, overwhelmed dealers' risk tolerances for buying back additional auction paper, and auctions began to fail (please see Auction Rate Securities, below). Auction-rate securities paying high penalty rates attracted investors away from other fixed- and floating-rate products, forcing both fixed and floating rates up sharply. At the end of February 2008, TOB programs were once again forced to sell bonds to pay margin calls, to unwind their leverage that had grown too expensive, and to afford investor redemptions. Extreme selling and uncertainty led to widely divergent pricing decisions across the industry; liquidity was almost completely interrupted, and state and local issuers were temporarily shut out of the capital markets. Once again, high yields galvanized demand in March, and from that point until December 2008, the municipal market continued to face boom and bust pricing cycles of sometimes extraordinary depth. In general, these entailed yield-fueled, or media-driven demand bubbles that were ultimately pricked by yet another bond insurer downgrade that renewed fears and sometimes forced selling by leveraged bondholders. The worst of these cycles began in September, when the collapse of Lehman Brothers, plus concerns over other broker-dealer counterparties were realized in investor redemptions from municipal money markets, which put large numbers of variable rate obligations back to dealers. The flow of bonds initially overwhelmed dealer balance sheets, forcing the unwind of some proprietary positions, but was ultimately managed through dramatically higher floating rates (the municipal industry's 7-day floating rate reset from about 2 percent to 8 percent and credit spreads to that rate widened sharply, in particular for TOBs because of their reliance on multiple layers of bank support) and the temporary withdrawal of a large number of floaters from active markets onto liquidity provider balance sheets. Still, higher floating rates forced many tender option bond programs to unwind their trades for perhaps the final time, as investors now began demanding their money back in earnest. The excess supply created by forced TOB selling in September to November, along with downgrades to the bond insurers, pushed municipal yields sharply higher, prices lower. Institutional buyers retreated from the public markets until the end of the year (although many large buyers were able to buy portfolios of highly discounted bonds in the evenings and weekends, muffling the implications of these very cheap trades on broader market pricing), causing credit spreads to widen dramatically. Spread widening and price declines hurt tax-exempt mutual fund net asset values, giving the appearance of undue credit risk to their investors and initiating perhaps the largest sequence of mutual fund investor outflows (and thus forced selling of related holdings by the funds) on record. And, as was well covered by the media, with fixed-rate yields having risen to extraordinary heights, many state and local issuers chose to table the majority of their planned primary market loans, waiting for conditions to improve. Indeed, smaller, lower-rated, and riskier credit issuers may have at least temporarily been unable to access capital at all, but large states and cities were always able to raise money; their decisions were based on price. MMA estimates that, in 2008, more than $100Bn of planned new-money infrastructure projects were delayed, the majority of that occurring in the fourth quarter. Persistent institutional demand has not yet returned to the municipal market, but since the start of 2009, municipal fund managers and brokerages have been highly successful attracting retail investment on the back of both flight-to-safety allocations (out of equities) and, more importantly, on speculation that the stimulus will ultimately drive up municipal bond prices. In fact, yields on the kind of bonds favored by retail investors touched two-decade lows in mid-January, although they have since begun to retreat again. Lower-rated, risky credit issuers (like hospitals) still face difficulty finding cost-effective market access and even highly rated state and local governments are commonly required to downsize new bond issues or risk pushing market yields higher.Summary of Regulation IssuesIntroduction The Municipal Securities Rule-making Board (MSRB) is a self-regulatory organization (SRO) and was formulated by Congressional statute in 1975. Please see the attached National Federation of Municipal Analysts White Paper``Federal Securities Law Relating to Municipal Securities,'' for background and more detail. During Thomas Doe's tenure as a Board member from 2003 to 2005, there was rarely a Board meeting where the subject of derivatives was not discussed and the risks to the industry and investors were not addressed. However, the outdated statute limited the Board's regulatory purview to municipal cash securities and to activities of dealers and dealer banks. Proactive action was inhibited for three reasons: (1) it was exceptionally difficult, however well intended, for Board members representing security firms to advocate for change that would reduce the revenue of its firm; (2) the volunteer nature of the Board resulted in a consistent deferral of strategy, tactics and policy to staff; (3) the Chairman of the Board served only one year and dictated the Board's focus, which, in our opinion, was to sustain the status quo and could again be heavily influence by staff. Since staff, especially the Executive Director, worked for the Board, it appeared to be exceptionally difficult for innovation and proactive regulation to occur. To be fair, there is now new leadership of the MSRB's staff. However, the negative characteristics of a: (1) short-tenured Chairman; (2) volunteer Board; and (3) the tremendous challenge to advocate for the investor or issuer interest, which could hurt an employer's revenue stream, are still present. These conditions can be inhibitive toward regulation in the best interest of the consumer--both issuers and investors.Opportunity In 2009, led by the catalysts of curtailed institutional demand, limited issuer access to the capital markets and the allegations revolving around municipal finance practices in New Mexico, the MSRB has suggested a review of the Congressional regulatory statute created 34 years ago. Specifically the Board has suggested an expansion of entities to be regulated swap advisors. The willingness of the Board to advocate change is applauded however, the action falls short.Necessary Change More entities should not alone be regulated, but rather legislative language should be expanded to be inclusive of all practices and products in which financial institutions would be involved related to municipal finance. By regulating the products, all entities involved with municipal finance--from creation to distribution--would be governed by transparency and regulations, which would advance and define a context for transactions in the municipal industry for the protection of issuer, dealer and investor. Only in this manner can responsibility and integrity be promoted and transparency ensured. The byproduct of such attention to derivatives would accomplish the disclosure required by issuers to both inform investors and those who choose to provide capital to public entities.Action Items 1. End the MSRB as an SRO. 2. Integrate the MSRB formally and directly into a larger entity, possibly the Securities Exchange Commission, Treasury or Federal Reserve. 3. Congress expand the regulatory purview of municipal regulation to include all participants in municipal finance and all financial tools involved in a municipal finance transaction--this would include derivatives and swaps in addition to the cash market. Along with dealers: advisors, ratings agencies, and evaluation services would be included in the new regulatory scheme. 4. Ensure that the regulatory statue was adaptable and flexible to allow regulation to be proactive and timely. 5. Include the municipal industry within an organization, where its regulatory framework, data and action can be more easily coordinated with larger markets. (Too often critical regulation may not have been enacted or suggested as the industry is small relative to equities and taxable fixed-income. One might argue that the vulnerability of the eclectic resources of the 65,000 municipal issuers/borrowers of the industry demands more vigilant protection because of the critical importance of the financings to essential services and projects for town, counties and states in the US.) 6. Mandate better regulatory coordination with its consumers-- specifically issuers and investors--not simply the dealer community. 7. Demand greater financial forensics to mine the vast municipal transaction data created by the Real-Time Transaction Reporting System in order to better indentify market behavior that can adversely impact (i.e., volatility) issuer pricing and investor evaluations. In addition, better data analysis can better define conditions of market liquidity to assist market participants in risk management strategies and investors to better use performance data measurements, specifically indices of price performance and returns. This report highlights significant areas where more robust data collection would have helped manage and avert systemic risks exposed in the credit crisis.Conclusion The municipal industry has evolved outside of a confined regulatory context that is outdated and biased, and been consistently challenged by the temptation to regulate in its self-interest. The evolution resulted in detrimental practices and products that have proved penal to investors, issuers and the financial institutions. The opportunity to broaden the current regulatory framework has presented itself and in acting to take steps to protect the public entities, which require access to capital for infrastructure, the new broad regulation of the municipal industry with specific attention to both derivatives and cash financial products will provide precedence for global regulatory reform of all derivatives. The best news is that the MSRB's current major funding mechanism, fees from municipal transactions (more than $20 million in 2008), provides a revenue stream to fund expansion and transition of the regulatory purview. In addition, the existing organizational infrastructure of the MSRB allows for experienced personnel, technology and data to be powerfully integrated in a revitalized context. The municipal regulatory entity must be independent of those it regulates and integrated within a regular Federal entity where the industry can be included and coordinated with regulation of the larger markets.Disclosure and Investor Protection For a background on municipal disclosure, MMA here quotes from the National Federation of Municipal Analysts March 2008 ``White Paper on Federal Securities Law Relating to Municipal Securities.'' The full paper is attached at the end of this report. The SEC promulgated Rule 15c2-12 (the ``Rule'' or ``Rule 15c2- 12'') in 1989 and amended the Rule in 1994 to include continuing disclosure requirements. . . . Direct regulation of issuers would have required repeal of the Tower Amendments, so the Rule instead applies to municipal broker-dealers and generally applies to financings where the principal amount offered is $1 million or greater. The Rule applies indirectly to issuers, effectively denying their access to the market unless the Rule's requirements are satisfied. The Rule contains primary disclosure requirements and continuing disclosure requirements. With respect to continuing disclosure, the Rule prohibits the purchase and sale of municipal securities by an underwriter in a public offering unless the issuer or an ``obligated person'' undertakes to provide continuing disclosure. Continuing disclosure obligations include both periodic reporting of financial and operating information and disclosure of the occurrence of any of a specified list of 11 events, if material. The annual information is required to include audited financial statements when available and material financial information and operating data of the type included in the official statement for the securities. . . . Independent of contractual undertakings made by issuers and conduit borrowers and continuing disclosure obligations under Rule 15c2-12, the SEC maintains that issuers of municipal securities and conduit borrowers have continuing disclosure responsibilities under Section 10(b) of the Exchange Act and Rule 10b-5. While issuers and conduit borrowers have no affirmative duty to disclose information (unless they are engaged in the offering, purchase or sale of securities or unless disclosure is required under a continuing disclosure undertaking), if an issuer or conduit borrower chooses to disclose information to the market it is prohibited from disclosing information that is materially untrue or misleading, or that contains a material omission, ``in light of the circumstances'' in which such information is disclosed. There are no other limits on the issuer's or the conduit borrower's disclosure. We also reference DPC Data's report, ``The Consequences of Poor Disclosure Enforcement in the Municipal Securities Market'' that provides more information on how disclosure is disseminated. Currently disclosure occurs through a regime of several repositories (Nationally Recognized Municipal Securities Information Repositories, or NRMSIRs), but, with recent change in law, a single repository will exist: the Municipal Securities Rulemaking Board. In MMA's opinion, the state of disclosure in the municipal sector should be regarded as poor, and recent changes in the law are unlikely to make much difference here. Issuers, as detailed by DPC data's important (and accurate) study on the topic, regularly fall out of compliance with stated disclosure requirements, undermining liquidity in selected bonds and hurting smaller investors (those without credit analysts trained to track down, or mitigate the impact of, absent financial and operating data) who buy bonds, in part, based on statements in the prospectus that regular information will be disclosed. In MMA's opinion, disclosure gaps occur because: (1) many issuer representatives are not capital markets professionals and lose track of their responsibilities, and (2) there is little penalty to be suffered by the industry for not policing compliance. A specific failing of SEC Rule 15c2-12 is its leaving the decision on whether an issuer is in disclosure compliance to the individual participants trading the issuer's securities. In our experience, firms have generally ignored this requirement and continued to trade likely safe, but disclosure-gapped bonds, albeit at a slight discount. Further, we note a pattern of smaller issuers falling out of compliance almost immediately after a new offering, remaining out of compliance for several years until, just prior to another new primary market loan, the issuer will send its past due financial information to the information repositories. Again, MMA believes a solution to municipal disclosure problems is available: 1. We believe Congress should require that the SEC act as arbiter to determine whether each issuer is in compliance with their stated disclosure requirements. This would be a very large undertaking, potentially requiring a large staff increase by the SEC. Should the SEC subsume the MSRB, the MSRB's funds could offset at least a portion of the cost. 2. Bonds found to be not in compliance would be flagged, and registered firms would be prohibited in trading in such until either the issue's original underwriter or any other investor can succeed in getting the issuer to remedy the gap. We are reluctant to advise that the SEC be able to compel disclosure directly from the issuers for fear of abridging state autonomy. 3. The SEC would keep a database to track, for every Cusip and borrower, the number and percent of days it has been out of compliance on all of its outstanding bond issues. This statistic would be vitally important for potential buyers evaluating new purchases of the borrower's securities. 4. Additionally, all firms trading municipal bonds, regardless of their status, would need to track how many trades, and the volume of par traded, that firm had made with disclosure- flagged municipals Cusips. Again, this could be very important data for investors evaluating with which firm to invest their money. 5. MMA also believes that all tax-relevant calculations and investigations should be included in required disclosure topics. These include how tax-exempt bond proceeds are being spent, on a weekly basis, the precise formula by which bond counsel determines that a bond issue is tax exempt, and the presence and status of any SEC investigations.The Undisclosed Risk of Bank Bonds and Swaps MMA's principal concern for the municipal sector in 2009 is that variable-rate related problems will set off a wave of downgrades and even defaults among risky sector credits (such as hospitals and private universities), creating incremental economic loss and threatening more investor aversion to municipal bonds generally. But the risks in variable-rate demand obligations are not exclusive to hospitals; many state and local governments also issued these securities and face very similar credit challenges. VRDOs are long maturity bonds where the interest rate is periodically (weekly, daily, etc.) reset by a remarketing agent--usually a dealer bank--who also attempts to make proprietary markets in these securities among a universe of the firm's clients with a strong focus on tax-exempt money market funds. VRDOs also entail some form of liquidity support (structured via a letter of credit or standby purchase agreement) from a highly rated bank. In other words, a bank is contractually obligated to become the immediate buyer of last resort for a VRDO, giving money market funds confidence in the liquidity of a VRDO investment. MMA estimates that there are about $500Bn of outstanding VRDOs at present; this number has likely increased from $400Bn since the start of 2008 reflecting numerous post-collapse ARS restructurings into VRDOs. Yet today's financial markets entail substantially more investor caution among banks and between credits generally, and large numbers of VRDOs have been rejected by the money funds because of their reliance on a damaged or downgraded liquidity provider (most notably DEPFA and Dexia) or connection to a downgraded bond insurer. In the absence of other investors or remarketing agents' inability to bring yet more bonds onto their own balance sheets, many of these rejected bonds have triggered their liquidity features, requiring the liquidity providers to buy these securities directly. Provider-purchased VRDOs are referred to as ``bank bonds,'' which the liquidity providers hold as available for sale for a period of time (for example, 90 days), but then convert to accelerated maturity term loans between the liquidity provider and the issuer. It is unclear whether any municipal bank bonds have actually yet converted to term loans, but their acceleration of principal and penalty interest rate would reasonably require either an immediate restructuring or a default forbearance agreement between provider and issuer. Because there is little hope for market interest in Dexia or DEPFA to improve, at some point, issuer defaults may become public. MMA estimates, based on our polling of industry sources, that there have been as many as $50Bn of rejected floaters, with perhaps $50Bn more being kept away from liquidity providers through special--and thus potentially temporary--intervention by securities dealers. MMA believes that the amount of bank bonds has fallen in 2009, as issuers are actively restructuring their bank bond obligations, although we underscore that we are unaware of any information being collected by any regulator or data provider on this topic. Interestingly, the rejection of many VRDOs by the money funds has worsened problems elsewhere in the municipal floating-rate markets. First, it has required liquidity providers to become more cautious in writing new policies, increasing the scarcity and cost of same for municipal issuers. Second, by removing large swathes of floaters from money fund ``approved'' lists, and noting: (1) the near complete absence of TOB-related lending by the money funds (see ``Background'' section above), and (2) large, fear driven investor inflows into the money funds, has created a severe supply/demand imbalance. Approved and available securities are scarce and--because the funds' alternative is not investing their funds at all--are being bid up to extremely low yields (weekly interest rates have been close to, or well below 1 percent since November). Low benchmark floating rates, along with very strong demand for long-maturity LIBOR swap rates, an unwinding of arbitrageurs' interest rate hedges, and a dearth of new municipal issuer derivative activity, has pushed the related long-maturity municipal swap rates to very low levels. And this movement in swap rates has greatly increased issuers' cost of terminating any outstanding swap, complicating the restructuring of any distressed VRDO position. Further, higher issuer swap termination costs have produced substantial cash drains away from issuers via requirements that the issuers collateralize their potential termination liability to their counterparty. (Many issuers had purchased bond insurance AAAs to ward off credit- or rate-driven collateralization requirements. But with the insurers' losing their ratings, many issuers are no longer shielded, sometimes removing cash to the detriment of normal operations.) As not-for-profit hospitals have been particularly large users of this debt structure, and as these same hospitals also face lower private pay revenues and strained governmental reimbursements, defaults are likely in the near term. Because swap positions are only dimly disclosed, even sophisticated municipal investors remain largely without information on their own portfolios' related risks. Once again, these municipal issuer exposures to systemic risks were accreted with little public disclosure or regulatory insight. Further, MMA is unaware of any municipal regulator or information provider systematically collecting information on the size and scope of this problem. This not only inhibits better projection of potential losses, but also prevents a more robust response from national regulators (e.g., Treasury, the Federal Reserve, the SEC) who are struggling to grasp the depth of the problem and coordinate their response with those in other asset classes. Solutions are well within Federal abilities. MMA recommends that Treasury extend subsidized loans to municipal issuers to terminate difficult swap positions, with the cost of those loans recouped by Treasury via a surcharge on all future issuer swap activity. This would allow issuers to restructure their obligations into fixed rate bonds, relieving liquidity provider balance sheets of troubled exposures, and potentially encouraging future policy writing.Auction-Rate Securities and Unchecked Systemic Risks Auction-Rate Securities (ARS) are long maturity bonds where the interest rate is periodically reset by auction among potential investors, or failing that, set manually by a bank pursuant to an index or (typically very high) fixed rate. Because they are valued at par, ARS were typically purchased by individual investors as a higher-yielding alternative to cash deposits. However, higher yields reflected the fact that an ARS holder cannot sell their bond without an identified buyer: a sharp distinction from other ``cash like'' instruments that required dealer banks to periodically step in as a buyer to prevent auctions from failing. In part because of this reliance on bank intervention, ARS programs were (and still are) set up as proprietary trading exchanges by individual dealers, inhibiting the easy flow of capital and information from program to program. The implications of the ARS structure, in the context of the municipal industry's systemic exposure to the bond insurers and the financial counterparties were little understood by issuers, investors, or the dealer banks themselves prior to 2007. It was the collapse of the bond insurers in 2007 that undermined investor confidence in ARS issuers and precipitated vast selling. (Remember that individual investors had long been sold on the AAA virtues of bond insurance; this myth was not so easy to dispel when bond insurer downgrades began). Banks were initially able to use their own cash to buy back securities, but in January 2008, bank risk tolerances prevented further purchases, and ARS auctions began to fail. Thus, current holders were left without a means to get out of their positions, and issuers were forced to pay sometimes highly punitive fixed interest rates. Since that time, MMA estimates that about two thirds of ARS issuers have restructured or refinanced their securities, although many remain unable to do so as: (1) refinances with liquidity-supported floating-rate debt require the purchase of a liquidity policy from a highly rated bank--these policies have become both scarce and expensive as U.S. banks have reduced lending; and (2) refinances with fixed-rate debt are prevented not only by the high fixed rates many lower-rated issuers must now pay, but also the sometimes staggering cost of terminating the interest rate swap most municipal issuers have connected to their bond sales (please see bank bonds section, above). Thus, many investors still remain stuck with highly illiquid securities that are paying well-below-market, index-linked interest rates. At issue is an unwillingness to allow ARS to trade at a discount to entice potential buyers, because of the increase in potential liability and because sub-par pricing of these holdings could result in additional waves of mark-to-market losses for the already stressed banks. Although private trading venues have emerged to provide emergency assistance to distressed clients needing to liquidate their holdings at any price, we are unaware of any broker dealer making sub-par markets in any ARS. On the other hand, several of the large banks have, on the intervention of state securities regulators, settled with their individual and small institutional investors, in effect buying ARS securities back at par. Indeed, the largest current holders of ARS are likely the dealer firms themselves that are still carrying their swollen inventories from 2008 and now the bonds purchased via settlement. ARS shows another breakdown in the municipal regulatory framework. While there are initiatives to improve ARS price discovery, no market participant (including investors, dealer banks, nor the regulators themselves) knows precisely how many ARS are outstanding (MMA's estimate was about $200Bn municipal ARS at the market's peak), how many bonds were being placed through each dealer program, how many ARS issuers were reliant on bond insurance for their marketing to investors, the extent and means by which these issuers were leveraging counterparty credit through interest rate derivatives, and how much dealer support was being directly extended to the market. The implications for systemic risk management, as now being discovered in the credit crisis, are clear in these questions, which can (and should) be extended to the still healthy, but periodically threatened, municipal VRDO market.Municipal Bond Ratings and Bond Insurance Most municipal bonds are rated on a different, more conservative rating scale than corporate bonds. Moody's and Standard & Poor's have shown that triple-A U.S. corporate bonds have up to 10 times the historical default rate of single-A municipals. In MMA's opinion, neither municipal issuers, nor the individual investors who own the large majority of outstanding paper or fund shares, understands this point. But instead of requiring more accurate ratings, the municipal industry (i.e., issuers, investors, and underwriters) has instead chosen to make bonds appear safer and more similar through bond insurance (the insurers are rated along the more generous corporate rating scale; much of the bond insurance model distills to simple arbitrage between the two rating scales). At its peak, the municipal bond insurance industry entailed just nine companies whose ratings were applied to more than 50 percent of annual municipal bond sales. And this invited massive systemic exposure into the municipal industry as the bond insurers carried in the risk of subprime mortgage-backed securities, the insurers' and the financial sectors' leverage of ratings on securitized debt, and failed rating agency models. Attached, please find our January 2008 report, ``MMA on Corporate Equivalent Ratings,'' and our April 2008 report, ``Second Research Note on Moody's,'' for more detail on the problem with how municipal bonds have been rated. In the last year, both Moody's and Fitch ratings strongly considered reforming their muni rating processes, but both have tabled these initiatives because of the recession. Standard and Poor's continues to deny the existence of separate rating scales for municipals and corporate bonds, but that agency has embarked on a plan of sweeping upgrades to selected municipal sectors. Finally, the U.S. House of Representatives considered the ``Municipal Bond Ratings Fairness Act of 2008,'' which MMA believes would, for little cost to taxpayers, successfully remediate much of the rating problem in our sector. We strongly recommend that Congress adopt this legislation in its current form. MMA has been a leader on the topic of ratings and the municipal sector's use of bond insurance; we welcome any opportunities to continue to educate Congress and its agents on these topics.Pricing and Evaluation Issues The events of the past 18 months have amplified the risks and challenges associated with illiquidity and limited price discovery for municipal bond investors and issuers. The municipal bond industry has been challenged with a troublesome irony. While municipal bonds have favorable low historical default risks, the securities can be illiquid. How can a safe investment not have liquidity? Inconsistency of primary market pricing, the eclectic composition and multitude of issuing entities, the penal and overly granular ratings scale, reduced number of liquidity providers, the diminished number of AAA bond insurers and the inability to manage interest rate and credit risk have contributed to the challenges for the markets transactions to provide evaluation services with sufficient price discovery. The result is that evaluations that represent the price that investors receive on their investment firm statements or the prices that comprise the net asset value of a mutual fund share may bear little resemblance to an execution price should an investor choose to buy or sell. In addition, the periodic illiquid market conditions and limited price can result in sharp volatility that can be misinterpreted as credit or default risk, either of which may not be valid. In this manner the data can misinform an investor and potentially prompt emotional and inappropriate investment decisions. These same characteristics can also increase the difficulty for municipal issuers to assess market conditions and accurately predict market demand to give context for the pricing of their primary market deal. An aggressive, investigative and knowledgeable regulator with access to all transactions and who conducted each transaction, can assist consumers--both the investor and borrower--with providing a context to ensure that the data is relied upon by consumers inspires confidence and provides an objective context in which investors and issuers can make decisions from the prices of their securities.Schedule of Additional Attachments MMA has attached the following documents, under separate Acrobat file, in support of the arguments made herein. NFMA White Paper ``Federal Securities Law Relating to Municipal Securities'' March 2008 DPC Data ``The Consequences of Poor Disclosure Enforcement in The Municipal Securities Market'' January 2009 Municipal Market Advisors ``Corporate Ratings for Munis'' January 2008 Municipal Market Advisors ``Second Research Note on Moody's'' April 2008 CHRG-111shrg51303--145 Mr. Kohn," I think it is a strategy worth pursuing. The SEC has proposed a series of changes in the regulation of the credit rating agencies to make them more transparent, to have them publish the history of what they have rated so people can judge, to make it so that if somebody starts shopping around from credit rating agency to credit rating agency, they have to publish that amount. So I think meanwhile there is a lot we can do to make the credit rating agencies better. Senator Merkley. Thank you. " FOMC20060629meeting--152 150,CHAIRMAN BERNANKE.," President Guynn, I just want to make a comment that, when I give my testimony, I will have the Committee’s forecasts for year and a half ahead, which are conditioned on optimal monetary policy; so I’ll be able to say that this is what we think we can achieve reasonably over the next year and a half. Any issue of where we may want to be in the very long run is, at this point, I think moot. I take your point that we have not, as a committee, decided even to announce a quantitative price stability measure much less choose a specific one, and perhaps we should be more cautious about that. But in the near term, as Vincent’s simulation showed, getting to the 1.5 percent in the simulations takes us five years. We don’t want to create an impression that we are trying to achieve that kind of objective in a year or a year and a half, and I will make that point very clear in my testimony. President Pianalto." CHRG-111hhrg51698--36 Mr. Greenberger," If I could address the question, I would urge you to keep the provision in the statute. Mr. Gooch talks about CDS buying protection. We are talking about naked CDS. With naked CDS, there is no need to protect. It is a bet that, in the case of subprime mortgages, that the homeowner will not pay his mortgage or her mortgage. These get paid off if the collateralized debt obligations fail. The collateralized debt obligations are a security interest in homeowners paying their mortgages. These are people who don't have the security interest in that. John Paulson, in 2007, took out these naked credit default swaps; and because there were so many forfeitures of your constituents, he was able to take home $4 billion that year. Now, he was lucky, because he got to the window when the people who were issuing the guarantees still had money. AIG ran out of money. And, by the way, you and I and your constituents are now sending money in the front door of AIG and Citigroup and others, so it will go out the back door to pay people who took a naked bet that homeowners would not pay their mortgages. Because you are having bets out there that have no reflection of the real economic debt, as Eric Dinallo told you, it is magnifying the problems by threefold, somebody says eight-fold. In other words, more people are betting the mortgages won't be paid than there are mortgages. With regard to your correlation between the SEC short and this, I believe that Chairman Cox, a former Member of the House of Representatives and President Bush's Chair of the SEC, wants to ban naked credit default swaps because it is a way to get around the regulated equity markets. In other words, if you think GM is going to fail, you buy a naked credit default swap on GM, even if you don't own a bond in GM. And then what do some of those people do? It is reported they go out and take every action they can take to encourage the failure of GM. In the case of insuring subprime loans, Barney Frank has made the point that when banks have gone in and tried to renegotiate to leave people in their houses, that hurts the people who have guarantees for the failure. So they are bringing lawsuits to prevent that renegotiation. These naked credit default swaps create the grossest form of moral hazard. From 1789, when this Republic was founded, to the mid-1990s we didn't have credit default swaps or naked credit default swaps. I ask you, are your constituents, when you go home, saying, please, please, please allow us to have naked credit default swaps? No. It is the bankers who got us into this problem who want these naked credit default swaps. They should be banned; and I believe if this Committee doesn't do it, it will be done by the SEC. And it will be the first step in the pillar to say the CFTC is not doing the job, let's get rid of it and put it in the SEC. " CHRG-111shrg382--11 Mr. Sobel," In my view, we live in a world in which regulation is a national-based activity, but we do have global markets, as you were outlining in your opening statements. I think the question is, how do we bring these forces together? My answer is, one, I think the United States, and the Secretary in particular, are exercising a great deal of leadership. The FSB agenda, I think, is aligned very much with our principles for regulatory reform. You see that very clearly in the agreements reached in Pittsburgh on capital. Second, I have talked about the effort to raise standards. Again, I think this is a strong international commitment. I think leadership committed to it. I think that is going to put extra backbone to the effort. This is definitely the case with respect to the systemically significant firms, to make sure that they operate under a tougher regime. You know, one area where we are always--the subject of gaps comes up relates to, for example, the non-cooperative jurisdictions. And here, I think the Secretary in March, just after assuming office, put forward a three-pronged approach to basically raise standards in the prudential tax information exchange and anti-money laundering effort, and this was a major aspect of the April summit. Since then, you have seen substantial progress. You have seen many tax information exchanges signed around the world. We have put in place a process through a global forum, an OECD body, to develop carrots and sticks, which will be announced in March 2010. And similarly, we are working through the FATF processes and a new FSB process to raise adherence to standard by all jurisdictions. So I think that when you raise this question about gaps and arbitrage, you are putting your finger on a definite issue, a totally legitimate issue, and as you said, it is not an easy one to deal with, but we are bound and determined to do our best and we have our eye on the ball. Senator Bayh. Thank you. I am going to turn to my colleagues now. They have been most patient. I just observe, I very much appreciate the focus of the Secretary, the hard work that is being done in the Department. I know this is a very difficult diplomatic issue. We have made some progress here and in some other tangentially related areas. The Swiss are beginning to perhaps change some of their practices with regard to tax avoidance and that sort of thing, but it is a challenge we face when nation states enforce the rules but the consequences of their lack of diligence and enforcement go way beyond the border of those nation states. And given the experience we have just come through, heaven help us if we permit a repetition. But I understand it is a very difficult issue. Senator Corker? Senator Corker. Mr. Chairman, thank you, and thank you for your testimony. I think it is great that the G-20 is working together on so many of these issues. I think it will be interesting to see whether, as time moves on, this solidifies or sort of fragments, which I think could be a challenge as you move ahead. One of the issues that has been mentioned is just the whole procyclical nature of the way that we deal with our financial markets. I think it is interesting, Mr. Sobel, that you shared that as one of the issues that you all are working on, obviously, at the G-20. Here in our country, I think as history records what is happening right now, it will say, as it has in the past, that the herd mentality took over and that our regulators helped create, in many ways, a self-fulfilling prophecy. I think that is happening right now as really insane things are being asked at the local markets by regulators because of their concern about various types of credits. Obviously, when the market is rising, everybody levers up against appreciating assets. What is it that is being looked at--I would say the first thing we need to do is look at home. I think the OCC is in many ways creating far greater problems in our country than would otherwise exist. I don't think it, I would bet on that in major ways. But what are we doing at the G-20 level to focus on the whole procyclical nature of the way regulators work? They exacerbate bubbles and exacerbate problems. " CHRG-111hhrg51698--448 Mr. Short," Markets don't always operate with perfect efficiency. But you could go back to some of the statements by people who were saying that the real price of oil should be $70 or $80 a barrel. It now happens to be $40 a barrel. So are we suggesting that we should raise the price of oil? I mean, markets won't get things right all the time, but they will get them more right than they will wrong. And, it is just a very slippery slope, in my mind, if you are trying to micro-manage a market. Because, ultimately, I think what those markets did--speculators got us to a market equilibrium faster than we otherwise would have. I don't like the price of oil being high, but it got there ultimately because of physical market conditions. " CHRG-111hhrg52397--156 Mr. Donnelly," Why would making those trades more transparent result in less competitive conditions for American companies, why would transparency harm their ability to manage risk instead of being stuck in a drawer at AIG that everybody in Indiana eventually has to pay for? Mr. Don Thompson. I think that is an excellent question, and I think that the first point I would make in response to it is we are broadly supportive of increased transparency in the OTC markets generally and particularly in the CDS markets. We have been working actively with the Fed and other regulators for the past 4 years to increase transparency, increase centralized clearing of standardized contracts, including many of the index products, which I mentioned to you in my earlier remarks, it is not at all the case that we are opposed to increase transparency in the OTC markets. We do think that one needs to be careful when making decisions about market structure as a public policy-maker, to consider not just the benefits of transparency but it does in certain cases have costs as well. And all we ask is that there be a thoughtful debate about the relative cost and benefit. " CHRG-111shrg55117--132 RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM BEN S. BERNANKEQ.1. Back in March, Secretary Geithner, who was FOMC Vice-Chair under you and Chairman Greenspan, said he now thinks easy money policies by central banks were a cause of the housing bubble and financial crisis. Do you agree with him?A.1. I do not believe that money policies by central banks in advanced economies were a significant cause of the recent boom and bust in the U.S. housing sector and the associated financial crisis. The accommodative stance of monetary policy in the United States was necessary and appropriate to address the economic weakness and deflationary pressures earlier in this decade. As I have noted previously, I believe that an important part of the crisis was caused by global saving imbalances. Those global saving imbalances increased the availability of credit to the U.S. housing sector and to other sectors of the U.S. economy, leading to a boom in housing construction and an associated credit boom. The role of global savings imbalances in the credit and housing boom and bust was amplified by a number of other factors, including inadequate mortgage underwriting, inadequate risk management practices by investors, regulatory loopholes that allowed some key financial institutions to assume very large risk positions without adequate supervision, and inaccurate assessments of risks by credit ratings agencies.Q.2. You said you think you can stop the expansion of the money supply from being inflationary. Does that mean you think the expansion of the money supply is permanent?A.2. Broad measures of the money supply, such as M2, have not grown particularly rapidly over the course of the financial crisis. By contrast, narrower measures, such as the monetary base, have grown significantly more rapidly. That growth can be attributed to the rapid expansion of bank reserves that has resulted from the liquidity programs that the Federal Reserve has implemented in order to stabilize financial markets and support economic activity. Nearly all of the increase in reserve is excess reserves--that is, reserves held by banks in addition to the level that they must hold to meet their reserve requirements. As long as banks are willing to hold those excess reserves, they will not contribute to more rapid expansion of the money supply. Moreover, as the Federal Reserve's acquisition of assets slows, growth of reserves will also slow. When economic conditions improve sufficiently, the Federal Reserve will begin to normalize the stance of monetary policy; those actions will involve a reduction in the quantity of excess reserves and an increase in short-term market rates, which will likely result in a reduction in some narrow measures of the money supply, such as the monetary base, and will keep the growth of the broad money aggregates to rates consistent with sustainable growth and price stability. As a result of appropriate monetary policy actions, the above-trend expansion of narrow measures of money supply will not be permanent and will not lead to inflation pressures.Q.3. Do you think a permanent expansion of the money supply, even if done in a noninflationary matter, is monetization of Federal debt?A.3. As noted above, growth of broad measures of the money supply, such as M2, has not been particularly rapid, and any above-trend growth of the money stock will not be permanent. Monetization of the debt generally is taken to mean a purchase of Government debt for the purpose of making deficit finance possible or to reduce the cost of Government finance. The Federal Reserve's liquidity programs, including its purchases of Treasury securities, were not designed for such purposes; indeed, it is worth noting that even with the expansion of the Federal Reserve's balance sheet, the Federal Reserve's holdings of Treasury securities are lower now than in 2007 before the onset of the crisis. The Federal Reserve's liquidity programs are intended to support growth of private spending and thus overall economic activity by fostering the extension of credit to households and firms.Q.4. Do you believe forward-looking signs like the dollar, commodity prices, and bond yields are the best signs of coming inflation?A.4. We use a variety of indicators, including those that you mention, to help gauge the likely direction of inflation. A rise in commodity prices can add to firms' costs and so create pressure for higher prices; this is especially the case for energy prices, which are an important component of costs for firms in a wide variety of industries. Similarly, a fall in the value of the dollar exerts upward pressure on prices of both imported goods and the domestic goods that compete with them. A central element in the dynamics of inflation, however, is the role played by inflation expectations. Even if firms were to pass higher costs from commodity prices or changes in the exchange rate into domestic prices, unless any such price increases become built into expectations of inflation and so into future wage and price decisions, those price increases would likely be a one-time event rather than the start of a higher ongoing rate of inflation. In this regard, it should be noted that survey measures of long-run inflation expectations have thus far remained relatively stable, pointing to neither a rise in inflation nor a decline in inflation to unwanted levels. A rise in bond yields--the third indicator you mention--could itself be evidence of an upward movement in expected inflation. More specifically, a rise in yields on nominal Treasury securities that is not matched by a rise in yields on inflation-indexed securities (TIPS) could reflect higher expected inflation. Indeed, such movements in yields have occurred so far this year. However, the rise in nominal Treasury yields started from an exceptionally low level that likely reflected heightened demand for the liquidity of these securities and other special factors associated with the functioning of Treasury markets. Those factors influencing nominal Treasury yields have made it particularly difficult recently to draw inferences about expected inflation from the TIPS market. The FOMC will remain alert to these and other indicators of inflation as we gauge our future policy actions in pursuit of our dual mandate at maximum employment and price stability.Q.5.a. Other central banks that pay interest on reserves set their policy rate using that tool. Now that you have the power to pay interest on excess reserves, are you going to change the method of setting the target rate?A.5.a. At least for the foreseeable future, the Federal Reserve expects to continue to set a target (or a target range) for the Federal funds rate as part of its procedures for conducting monetary policy. The authority to pay interest on reserves gives the Federal Reserve an additional tool for hitting its target and thus affords the Federal Reserve the ability to modify its operating procedures in ways that could make the implementation of policy more efficient and effective. Also, the Federal Reserve is in the process of designing various tools for reserve management that could be helpful in the removal of policy accommodation at the appropriate time and that use the authority to pay interest on reserves. However, the Federal Reserve has made no decisions at this time on possible changes to its framework for monetary policy implementation.Q.5.b. Assuming you were to make such a change, would that lead to a permanent expansion of the money supply?A.5.b. No. These tools are designed to implement monetary policy more efficiently and effectively. Their use would have no significant effect on broad measures of the money supply. It is possible that such a change could involve a permanently higher level of reserves in the banking system. However, the level of reserves under any such regime would still likely be much lower than at present and, in any case, would be fully consistent with banks' demand for reserves at the FOMC's target rate. As a result, the higher level of reserves in such a system would not have any implication for broad measures of money.Q.5.c. Would such an expansion essentially mean you have accomplished a one-time monetization of the Federal debt?A.5.c. No. If the Federal Reserve were to change its operating procedures in a way that involved a permanently higher level of banking system reserves, it is possible that the corresponding change on the asset side of the Federal Reserve's balance sheet would be a permanently higher level of Treasury securities, but the change could also be accounted for by a higher level of other assets--for example, repurchase agreements conducted with the private sector. The purpose of any permanent increase in the level of the Federal Reserve's holdings of Treasury securities would be to accommodate a higher level of reserves in the banking system rather than to facilitate the Treasury's debt management.Q.6. Is the Government's refusal to rescue CIT a sign that the bailouts are over and there is no more ``too-big-to-fail'' problem?A.6. The Federal Reserve does not comment on the condition of individual financial institutions such as CIT.Q.7. Do you plan to hold the Treasury and GSE securities on your books to maturity?A.7. The evolution of the economy, the financial system, and inflation pressures remain subject to considerable uncertainty. Reflecting this uncertainty, the way in which various monetary policy tools will be used in the future by the Federal Reserve has not yet been determined. In particular, the Federal Reserve has not developed specific plans for its holdings of Treasury and GSE securities.Q.8. Which 13(3) facilities do you think are monetary policy and not rescue programs?A.8. The Federal Reserve developed all of the facilities that are available to multiple institutions as a means of supporting the availability of credit to firms and households and thus buoying economic growth. Because supporting economic growth when the economy has been adversely affected by various types of shocks is a key function of monetary policy, all of the facilities that are available to multiple institutions can be considered part of the Federal Reserve's monetary policy response to the crisis. In contrast, the facilities that the Federal Reserve established for single and specific institutions would ordinarily not be considered part of monetary policy.Q.9. Given the central role the President of the New York Fed has played in all the bailout actions by the Fed, why shouldn't that job be subject to Senate confirmation in the future?A.9. Federal Reserve policy makers are highly accountable and answerable to the Government of the United States and to the American people. The seven members of the Board of Governors of the Federal Reserve System are appointed by the President and confirmed by the Senate after a thorough process of public examination. The key positions of Chairman and Vice Chairman are subject to presidential and congressional review every four years, a separate and shorter schedule than the 14-year terms of Board members. The members of the Board of Governors account for seven seats on the FOMC. By statute, the other five members of the FOMC are drawn from the presidents of the 12 Federal Reserve Banks. District presidents are appointed through a process involving a broad search of qualified individuals by local boards of directors; the choice must then be approved by the Board of Governors. In creating the Federal Reserve System, the Congress combined a Washington-based Board with strong regional representation to carefully balance the variety of interests of a diverse Nation. The Federal Reserve Banks strengthen our policy deliberations by bringing real-time information about the economy from their district contacts and by their diverse perspectives.Q.10. The current structure of the regional Federal Reserve Banks gives the banks that own the regional Feds governance powers, and thus regulatory powers over themselves. And with investment banks now under Fed regulation, it gives them power over their competitors. Don't you think that is conflict of interest that we should address?A.10. Congress established the makeup of the boards of directors of the Federal Reserve Banks. The potential for conflicts of interest that might arise from the ownership of the shares of a Federal Reserve Bank by banking organizations in that Bank's district are addressed in several statutory and policy provisions. Section 4 of the Federal Reserve Act provides that the board of directors of Reserve Banks ``shall administer the affairs of said bank fairly and impartially and without discrimination in favor of or against any member bank or banks.'' 12 U.S.C. 301. Reserve Bank directors are explicitly included among officials subject to the Federal conflict of interest statute, 18 U.S.C. 208. That statute imposes criminal penalties on Reserve Bank directors who participate personally and substantially as a director in any particular matter which, to the director's knowledge, will affect the director's financial interests or those of his or her spouse, minor children, or partner, or any firm or person of which the director is an officer, director, trustee, general partner, or employee, or any other firm or person with whom the director is negotiating for employment. Reserve Banks routinely provide training for their new directors that includes specific training on section 208, and Reserve Bank corporate secretaries are trained to respond to inquiries regarding possible conflicts in order to assist directors in complying with the statute. The Board also has adopted a policy specifically prohibiting Reserve Bank directors from, among other things, using their position for private gain or giving unwarranted preferential treatment to any organization. Reserve Bank directors are not permitted to be involved in matters relating to the supervision of particular banks or bank holding companies nor are they consulted regarding bank examination ratings, potential enforcement actions, or similar supervisory issues. In addition, while the Board of Governors' rules delegate to the Reserve Banks certain authorities for approval of specific types of applications and notices, Reserve Bank directors are not involved with oversight of those functions. Moreover, in order to avoid even the appearance of impropriety, the Board of Governors' delegation rules withdraw the Reserve Banks' authority where a senior officer or director of an involved party is also a director of a Reserve Bank or branch. Directors are also not involved in decisions regarding discount window lending to any financial institution. Finally, directors are not involved in awarding most contracts by the Reserve Banks. In the rare case where a contract requires director approval, directors who might have a conflict as a result of affiliation or stock ownership routinely recuse themselves or resign from the Reserve Bank board, and any involvement they would have in such a contract would be subject to the prohibitions in section 208 discussed above.Q.11. Do you think access to the discount window should be opened to nonbanks by Congress?A.11. The current episode has illustrated that nonbank financial institutions can occasionally experience severe liquidity needs that can pose significant systemic risks. In many cases, the Federal Reserve's 13(3) authority may be sufficient to address these situations, which should arise relatively infrequently. However, a case could be made that certain types of nonbank institutions, such as primary dealers, should have ongoing access to the discount window; any such increased access would need to be coupled with more stringent regulation and supervision. The Federal Reserve also believes that the smooth functioning of various types of regulated payment, clearing, and settlement utilities, some of which are organized as nonbanks, is critical to financial stability; a case could also be made that such organizations should be granted ongoing access to discount window credit.Q.12. Do you think any of the 13(3) facilities should be made permanent by Congress?A.12. As noted above, the issue of appropriate access to central bank credit by certain types of nonbank financial institutions deserves careful consideration by policy makers. The financial crisis has illustrated that various types of nonbank financial institutions can experience severe liquidity strains that pose risks to the entire financial system. However, whether access to the discount window should be granted to such institutions depends on a wide range of considerations and any decision would need to be based on careful study of all of the relevant issues.Q.13. For several reasons, I am doubtful that the Fed or anyone else can effectively regulate systemic risk. A better approach may be to limit the size and scope of firms so that future failures will not pose a danger to the system. Do you think that is a better way to go?A.13. I believe that it is important to improve the U.S. financial regulatory system so as to contain systemic risk and to address the related problem of ``too-big-to-fail'' financial institutions. The Federal Reserve and the Administration have proposed a number of ways to limit systemic risk and the problem of ``too-big-to-fail'' financial institutions. Imposing artificial limits on the size of scope of individual firms will not necessarily reduce systemic risk and could reduce competitiveness. A challenge of this approach would be to address the financial institutions that already are large and complex. Such institutions enjoy certain competitive benefits including global access to credit. At any point in time, the systemic importance of an individual firm depends on a wide range of factors. Size is only one relevant consideration. The impact of a firm's financial distress depends also on the degree to which it is interconnected, either receiving funding from, or providing funding to, other potentially systemically important firms, as well as on whether it performs crucial services that cannot easily or quickly be executed by other financial institutions. In addition, the impact varies over time: the more fragile the overall financial backdrop and the condition of other financial institutions, the more likely a given firm is to be judged systemically important. If the ability of the financial system to absorb adverse shocks is low, the threshold for systemic importance will more easily be reached. Judging whether a financial firm is systemically important is thus not a straightforward task, especially because a determination must be based on an assessment of whether the firm's failure would likely have systemic effects during a future stress event, the precise parameters of which cannot be fully known. I am confident that the Federal Reserve is well positioned both to identify systemically important firms and to supervise them. We look forward to working with Congress and the Administration to enact meaningful regulatory reform that will strengthen the financial system and reduce both the probability and severity of future crises.Q.14. Given your concerns about opening monetary policy to GAO review, what monetary policy information, specifically, do you not want in the hands of the public?A.14. The Federal Reserve believes that a substantial degree of transparency in monetary policymaking is appropriate and has initiated numerous measures to increase its transparency. In addition to a policy announcement made at the conclusion of each FOMC meeting, the Federal Reserve releases detailed minutes of each FOMC meeting 3 weeks after the conclusion of the meeting. These minutes provide a great deal of information about the range of topics discussed and the views of meeting participants at each FOMC meeting. Regarding its liquidity programs, the Federal Reserve has provided a great deal of information regarding these programs on its public Web site at http://www.federalreserve.gov/monetarypolicy/bst.htm. In addition, the Federal Reserve has initiated a monthly report to Congress providing detailed information on the operations of its programs, types, and amounts of collateral accepted, and quarterly updates on Federal Reserve income and valuations of the Maiden Lane facilities. This information is also available on the Web site at http://www.federalreserve.gov/monetarypolicy/bst_reportsresources.htm. The Federal Reserve believes that it should be as transparent as possible consistent with the effective conduct of the responsibilities with which it has been charged by the Congress. The Federal Reserve has noted its effectiveness in conducting monetary policy depends critically on the confidentiality of its policy deliberations. It has also noted that the effectiveness of its tools to provide liquidity to the financial system and the economy depends importantly on the willingness of banks and other entities in sound financial condition to use the Federal Reserve's credit facilities when appropriate. That willingness is supported by assuring borrowers that their usage of credit facilities will be treated as confidential by the Federal Reserve. As a result of these considerations, the Federal Reserve believes that the release of detailed information regarding monetary policy deliberations or the names of firms borrowing from Federal Reserve facilities would not be in the public interest. ------ CHRG-111hhrg58044--371 Chairman Gutierrez," I thank the gentlelady. I guess the claim--because I think when we go back through the record, we are going to find that even the insurance representatives keep going back to the likelihood of filing a claim. I have a feeling that I think I know the answer to that, and that is if you make more money, you are probably less likely to file a claim. That is to say, let's say you have insurance on your house. You burn something, right? Cause some damage. You are probably more likely to just take care of it yourself, given your extra income and your income status than filing a claim, because you do not want your insurance premiums to increase. Somebody bangs into your car. You are likely to take care of it. You are less likely to take care of it and file a claim if you make less money. It is really about the likelihood of a claim, I think, more. We are going to delve into this. Given the fact--I think Mr. Green--they keep using the words ``likelihood of claim.'' Not likelihood of having an accident, the likelihood of filing a claim. I think we have to look at that. I would like to say our purpose here is not to deny people access to information, but correct information, accurate information, information that truly reflects who they are. I want people to get good information but I do not want people to get bad information. I think we do have a responsibility. As a matter of fact, the Equal Opportunity Commission has gone and said that using information from credit reports for employment is discriminatory. They are leading actions against that. People are doing that. It is interesting that Mr. Pratt represents three of the people who do the credit industry, and here are the credit bureaus. Equifax decided last year to stop selling it. They said no, we are not going to do that any more. Do you know why, Mr. Pratt, they decided to stop selling it for employment purposes? " FOMC20071031meeting--81 79,MR. KROSZNER.," Thank you very much. I very much agree with Dave’s characterization of the Greenbook as a modal forecast, and I think it is an excellent and perfectly reasonable modal forecast. As almost all of us have said, the data are coming in a little stronger. We will have a fair amount of momentum going into the fourth quarter. We will have a significant drag from housing in ’08. The financial markets outside of housing have generally had fairly significant improvement, although a lot of brittleness remains. A very clear example of that is how the markets seemed to flatten out in the past week or so and certain markets backed up a bit, and thus the risk spreads are widening. It is also interesting to note that, when the first earnings reports that were fairly negative were coming out, there was a positive market reaction because it was sort of a relief that they were owning up to the challenges. Now that more information is coming out, some of which is more negative than had been expected, the market’s reactions have been more negative, and some of the risk spreads have been widening. That suggests that a lot of concern is still out there, and a lot of people are waiting for the other shoe to drop. I will note that I am sure that other shoe will have been manufactured in Richmond. [Laughter] Since this was a modal forecast, I want to think about a downside scenario, one on which I put a reasonable amount of probability mass and one that I think we should seriously consider. A number of people have talked about bank balance sheets. Generally, there has been less concern about them than before. One of the big issues that we had focused on earlier was leveraged lending. That seems to be working itself out reasonably well without much incident. There is obviously a lower new flow on, but the new flow does have covenants, et cetera. So that seems to be working out reasonably. ABCP, SIVs, conduits—there is still uncertainty about how much may come onto the balance sheets, although there is a lot more comfort with the extent of the call on the capital that is there, but there is still uncertainty as to how much might be called. You know, the SIVs seem to be working themselves down. They are shrinking through orderly asset sales. But, of course, what are they doing? They are selling the best assets first, so the potential challenges are still left behind. For the banks, the conforming mortgages are easy to get off the balance sheets. There seems to be a debate about whether banks are choosing not to get nonconforming ones off the balance sheet or whether they can’t get them off the balance sheet. Many organizations that have a lot of capital seem to be just originating these wholly on the balance sheet and waiting for better pricing, as we have heard reports from other institutions saying that they are ready, willing, and able to buy at a good price and the supply just isn’t there. Nonetheless, there is still much more carefulness in the underwriting of those loans. Obviously, the jumbo mortgages, the nonconforming mortgages, are more important than they used to be because housing prices have run up so much around the country: $417,000 doesn’t buy you as much house anymore, even in parts of the country that don’t have or traditionally have not had particularly high housing prices. That raises a concern about a squeeze through the mortgage markets. So I see that the consequence of the financial turbulence is primarily highlighting issues in the mortgage markets, as a number of people have said. Also, as I think the Greenbook and Bluebook pointed out, it is not a problem for highly rated or even just moderately well rated corporations to get funding. That is not a challenge right now. It seems mainly to be coming through the housing market. So I see a potential for a slow-burn scenario coming and for the housing market to slowly play itself out because we are going to have continuing negative shocks. More than 400,000 resets are going to be coming every quarter, starting with this quarter, through 2008. As a number of people have noted, we have much higher credit standards than before. Many of the people who were supplying subprime loans no longer exist, and those who are supplying them are supplying them at much, much higher standards. We will be proposing and putting out new rules. The Congress is considering new rules. This is all casting a pall over people who might potentially be supplying credit into some of these markets. The delinquencies and foreclosures are clearly going to continue rising at least for a few quarters, probably—as analysis by some people at the Board suggests—peaking in mid-2008. But there is still a lot of uncertainty with respect to that. So it is going to continue to put more and more challenges in this market. All of these things coming together could put a lot more pressure on housing prices. I think we have been seeing some significant declines in housing construction, but I see a potential for a reasonable likelihood of a much larger negative house-price effect than what the Greenbook has. As a shred of evidence for that, the incredibly illiquid Case-Shiller index that is traded on the Mercantile Exchange, if you look forward, for a number of markets they have a cumulative decline of 20 percent over a couple of years. Now, the number of players may be no more than the number of fingers that I have, but still it is a piece of data suggesting that it could be lower. The anecdotal reports are that real housing prices are much lower than the indexes are indicating. Certainly, in the new market, they are throwing in a lot of extras, add-ons, et cetera, and the inventory may actually be larger because the anecdotal reports are that a lot of people are taking their houses off the market, so they are not formally included in the enormous inventories that are out there but may well be potentially there for supply. So what does this suggest going forward? Well, from a risk-management perspective, we ought to be thinking about buying insurance against this downside scenario. What is the cost of insurance? Inflation and inflation expectations. As most people have mentioned, we have seen some gradual slowing and expectations are still being contained but, as Governor Kohn pointed out, there is a bit of an uptick in the CPI, which is definitely worrisome. But what is the risk? Well, let us think about the upside risk. I go back to 1998, when the FOMC cut 75 basis points. Growth was 4.5 percent in 1998 and 4.7 percent in 1999. As I mentioned last time, we saw very little increase in inflation—actually a decline in core inflation. I looked at the core PCE in addition to the core CPI that I reported last time, and that was effectively flat at 1.4, 1.6 percent in ’98 and ’99 and then 1.6 percent again in 2000. The potential benefit of buying a little insurance now is that, given that a lot of these challenges may be peaking in mid-2008, it may have some effect down the line. It provides perhaps a bit more insurance against some of the negative shocks that we may be hearing about. If those other shoes do drop over the next few months, then we have a lower downside risk for broader financial turbulence. Also, by mid- 2008, if the scenario that I am describing or the other negative scenarios that people have described, aren’t materializing, we can take back some of these moves. Thank you." FOMC20070321meeting--113 111,MR. KOHN.," Thank you, Mr. Chairman. Like many others, I view the data over the intermeeting period as not fundamentally undermining the basic contours of our expected forecast. We’re still on track for moderate growth and gradually ebbing inflation. The economy has enough underlying strength, bolstered by financial conditions that remain quite supportive of growth, so that the housing correction should not be enough to knock the economy off the moderate growth track. Growth modestly below potential, along with the unwinding of some special factors like rent increases, should allow further declines in inflation. Real-side data reflect the fact that the downshift from above-trend growth for several years to expansion at or a little below trend hasn’t been entirely smooth, and maybe we never should have expected it to be so. Besides the overpricing and overbuilding of housing, businesses apparently built their stocks of inventories and fixed capital in anticipation of continued strong growth, and we’re seeing downshifts in demand for inventories and capital to align them with the slower pace of expected growth. Businesses typically also hoard labor under these circumstances, resulting in weaker productivity growth, and we may just be seeing this adjustment getting under way, judging from the gradual upcreep in initial and continuing claims. The inherently uneven nature of the stock adjustment process and the uncertainty around it help to explain both the overall contours of the recent data and the short-run swings in the data and perceptions of them. A number of factors, most of them mentioned by others, do support expectations of moderate growth ahead. Outside the subprime market, financial conditions remain supportive of growth. Intermediate and long-term rates are low in real as well as in nominal terms. The dollar has fallen. The fallout from the recent turbulence has been very limited. Aside from housing, a good portion of the inventory correction is behind us or is being put behind us. So over time production ought to line up better with sales. Both a rise in the national ISM index and increases in industrial commodity prices, especially in metals, support the notion of a coming recovery in manufacturing, though I admit the increase in metals prices may be a factor of the global economic expansion as well. Continued good growth of jobs to date will support increases in personal income, and as many have remarked, growth in the rest of the world has been pretty strong. I was struck by the upward revision in rest-of-world growth in the Greenbook despite weakness in the United States, the rise in oil prices, and the decline in equity values. So as Karen remarked, domestic demand abroad seems to be strengthening, and I think this bodes well for global external adjustment as well as for U.S. exports. But the information we have received over the intermeeting period not only shifted expected growth down a little but also highlighted some downside risk to activity. In housing, those downside risks center on the implications of the subprime debacle. Will it affect housing demand? Will lending terms tighten beyond the subprime market and the mortgage market? How much will tightening spill over to other lending markets, such as home equity lines of credit, and perhaps affect consumer demand? The possible answers to these questions seem to me to have downside tails that are fatter than the upside tails. Unexpected weakness in investment spending outside housing and auto-related industries is another risk factor. The question is whether this weakness represents just a short-term adjustment to moderate growth or whether businesses themselves see a downside shift in underlying demand that we don’t see. Financial conditions may not remain as supportive of growth, besides the possibility of the dropping of other shoes, such as private equity, as many have mentioned. I see a distinct downside risk to the staff’s assumption of continued increases in equity prices given the likelihood that, if the economy evolves the way the staff anticipates, long-term interest rates will rise and profits will be very disappointing to market analysts. Despite weaker spending, we still face upside risks to the gradual downdrift in inflation. Recent data haven’t been as favorable to deceleration as we would have hoped: Softer investments, slower growth of productivity, and continued strength in labor markets could suggest a slower path of trend productivity growth. If so, we would need to adjust down our expectations for growth, and labor costs would get a boost even at slower growth rates unless increases in nominal wages also downshifted pretty promptly. Good growth in labor demand could suggest a stronger path for demand and less slack than the staff is estimating. Finally, the NAIRU could well be lower than the 5 percent that the staff is estimating, especially in light of the relatively slow updrift in many measures of compensation. But, at 4½ percent, the unemployment rate is low by historical standards, and this suggests to me that the risks from resource utilization remain toward higher inflation. In sum, downside risks to our maximum employment objective have increased, but I do not think they outweigh the continuing upside risk to more-moderate inflation, at least not yet. Thank you, Mr. Chairman." CHRG-110hhrg38392--122 The Chairman," The gentlewoman from Ohio. Ms. Pryce. Thank you, Mr. Chairman. Thank you, Mr. Chairman, for the time you take with us in these Humphrey-Hawkins marathons twice a year. You are very gracious. I know you are required to do it, but thank you for doing it so graciously. I also want to thank you for the initiatives the Fed has taken in terms of consumer protections, especially in my State of Ohio, with the mortgage problems that we are having. Your attention to that is critical and very, very much appreciated. So thank you for that. I would like you to talk a little bit today to us about the extent and the impact of the use of credit or the overuse of credit, as Mr. Paul might refer to it, in our country. I am particularly interested in credit card debt, but you can go beyond that if you would like, because I think that this committee will be addressing some of those issues in the fall. We would love to have some of your guidance in terms of consumer protections when it comes to things like data breaches. In my home State of Ohio, we have had major financial institutions, universities, retailers--even our own State government has had just a series of terrible breaches in data and has the identity theft issues that go along with those things. Credit is a wonderful convenience, and credit is one thing that is keeping our economy healthy or unhealthy, as the case may be in your perspective. How can we better address the issue of data breaches and securing people's information in every way we use it when the use of credit is so pervasive and is on the Internet? " CHRG-109shrg21981--83 Chairman Greenspan," No. Let me see if I can come back at this. If in its original form we did not have anything other than a requirement that we had 12.4 percent tax which was put into a private account, in other words, that particular fund coming off the person's income and the employer's income would go into a forced savings account. In a sense private savings would increase by that amount, and the part that the corporation contributed which would have reduced its undistributed earnings, which would have been savings, would be a negative. But net it would, except under a certain number of distant conditions, it would be a net increase. Senator Crapo. So the employer's savings would be reduced but the employee's savings would have gone up, and there would be a net zero balance? " CHRG-111hhrg56766--19 Mr. Paulsen," Thank you, Mr. Chairman, for being here this morning as well. I have two issues of particular concern and hopefully, you will be able to address them. The first is the lack of available credit for the small business community and the fear that if the Fed raises interest rates in the near term, it will further erode credit opportunities for small business and exacerbate that problem. I would like to hear about the potential of the Fed Reserve increasing rates in the near future and ensuring that credit for small businesses is going to be available for job growth. Second, the issue of the explosion of the deficit and the debt, and the warning signals are getting louder that our fiscal situation is putting increasing pressure on our bond rating. I would like your opinion on the long-term impact of not addressing our debt as it relates to our bond rating, but more importantly, the impact it would have on our global competitiveness. Thank you and I do look forward to your testimony. " CHRG-111hhrg48874--81 Mr. Manzullo," We know, Mr. Long, we know of business after business that has never had a problem with their line of credit, they're being cut off on lines of credit. They're throwing their arms up in the air, and suffering. But I know you're going to look at it, because I know where your heart is. And it is in the field with those people and the people who want to borrow the money. And I appreciate that. Thank you. " CHRG-111shrg61513--115 Mr. Bernanke," We are doing so. I guess I would first mention that our mortgage-backed security purchases---- Senator Reed. Yes. " Mr. Bernanke,"----lowered the mortgage rate and allowed for some millions of refinances, which I am sure has been helpful. As you know, the leadership in terms of actual programs is the Treasury's program, the HAMP program, and there are a few others, the Help for Homeowners and those, and we felt that our best way of contributing is to be supportive of those things and to strongly encourage both banks and, in our case, as consolidated supervisors, we also have supervisory responsibilities for non-bank subsidiaries, whether it is some servicers or mortgage companies or whatever, to participate and to be effective in those programs. And we have for some time now been both looking for solutions to barriers, legal or accounting barriers, and we have been doing research to try to support these programs. For example, we have long felt that the problem of being underwater, the principal issue, is a serious one, and so that was why we were supportive of some of these efforts, like the Hope for Homeowners, that involves a principal reduction. Unfortunately, that program apparently has not been successful in bringing in a lot of participation, but we continue to look at different approaches to get restructuring. I think it is encouraging. The Treasury, I know, is not only trying to do their best to ramp up the HAMP program, and I think we will see more permanent modifications coming in since they have a pretty big pipeline at this point, but they are also doing some pilot programs that involve alternative approaches. For example, one problem that their approach doesn't deal with is the problem of somebody who is unemployed, can't even make a reduced payment. So what is needed there is not a permanent modification but some temporary assistance. Another issue has to do with principal reduction. So in some of their pilot programs, I think they are looking to try to take some of these different approaches. We have worked with them, our economists worked with their economists, and we have been very engaged in trying to figure out what is the best approach. It is a very hard problem. Unfortunately, many foreclosures are just hard to avoid for a wide variety of reasons. But where there is a preventable foreclosure, it is not only in the interest of the borrower, but in the interest of the bank and of the whole economy to try to avoid it. Senator Reed. I will concede, it is a difficult problem, but sometimes you have got to send a very strong message. For example, you know, could you set a goal, maybe institution by institution of modifications as a condition to access your credit facilities? These institutions are borrowing money at virtually zero percent and then they are turning around saying, we can't modify a loan because of the interest, or we will do, from 8 percent, we will cut it 50 basis points, when essentially many of these people, when they pay their taxes, they are giving them zero percent loans. " CHRG-110hhrg44903--133 Mr. McHenry," Because in terms of material information, I think that has to be clarified so that you can take those actions and steps necessary. Because, after all, part of the credit challenges that we are facing currently are because the credit rating agencies did not accurately detail the risks in the marketplace and actually rate products effectively. And another question for both of you, but starting with you, Chairman Cox, is the SEC--and to you, Mr. Geither. Are you all studying the implications of the FASB fast tracking and elimination of the qualified special purpose entities? Basically, what allows for securitization in the marketplace. Are you studying the effects that this rulemaking--because they are trying to push it and have it implemented by the end of the year--could have in the marketplace? After all, in my opinion, the Federal Reserve, but more importantly the Treasury, stepped in on Fannie Mae and Freddie Mac because of a report, a Lehman Brothers report, that explained the risks going forward with the FASB rule the possibility that they might need $75 billion in capital. And that was just based on an assumption that the rule would go into place. So this FASB rule about qualified special purpose entities, if you could discuss that. " CHRG-111hhrg48674--119 Mr. Bernanke," So, as I have tried to emphasize throughout the hearing, there are two types of intervention. There are the interventions that have involved trying to stabilize systemically critical firms whose failure would create substantial problems for the financial system and the economy. As I have indicated, I am very unhappy about having to be involved in those things, and the sooner I can shed that responsibility, the happier I will be. On the other side, the other type of activities has to do with our expansion, trying to create and stimulate credit markets where credit markets have broken down. And there, we want to keep looking for situations where we believe we have tools that can get the markets working again; that will create lower rates or better credit availability; and will stimulate the economy. I think those things are in the interests of the people and that it can be explained to them that it is in their interests. I don't know how much more, but I think, given the severity of the situation, that we do expect to expand somewhat more to address the severe dislocations we are seeing in a number of key credit markets, including consumer credit markets " FOMC20071031meeting--45 43,MR. FISHER.," By that I mean, by the way, that the subprime market is a focus of angst, which it should be, but the ridiculous practice of the suspension of reason in valuing all asset classes, if not over, is in remission. We have a long way to go before full recovery and must acknowledge that shocks regarding access might occur. I am confident, as I have said in previous meetings, that—just to be polite—some cow patties might show up in the punchbowls of some portfolios, perhaps especially in Europe and Asia. But I would submit, Mr. Chairman, that we are on our way back to markets priced by reason rather than by fantasy. So, while we must remain ready to act as needed, I think it is appropriate to focus our discussion today and tomorrow foursquare on the economy, and I want to turn to that now. The wealth effect of the severe markdown in housing is as yet incalculable and worrisome. As the Greenbook states and my sounding with CEOs confirms, there are as yet no appreciable, let alone debilitating, signs of spillover into the rest of the economy. The economy has been weakened. You see it in the rails and trucking and retail. It has not shown signs of succumbing as much as one might have expected to the full-blown virus that is afflicting housing. As Dave mentioned, going back to July, banks in our District and everywhere else have reported tightening terms and standards on loans to businesses and households. The overall sentiment or mood of the country, as reported by the press and the surveys, is sour. Yet we haven’t seen sharp increases in initial claims, low PMI (purchasing managers index) readings, or sharply falling durable goods orders. Households are still reasonably optimistic about their job prospects. Consumer spending continues to grow, albeit at a slower pace. The CEO of Disney started his discussion with me this time by saying, “I hate to be the bearer of good news,” and went on to cite an internal survey they recently completed that shows that families plan to spend liberally on vacations, despite setbacks in presumed housing prices, as well as strong ad statistics for their broadcasting network. There remain widespread reports of labor shortages, not just in our District but also elsewhere. The bottom line, Mr. Chairman, is that, there is clearly a fat left tail on growth—the economy is growing slower. But the economy is growing at a positive pace. Some might say that it has slowed to a sustainable pace. In part, this is due to infrastructure investment, spending on nondefense capital goods that is better than expected, decent if not robust E&S demand, fiscal stimulus, and strong export performance that we talked about earlier, assisted by superior demand growth abroad, facilitated by a progressively weaker dollar. I note that we meet the day after the trade-weighted dollar celebrated a post–Bretton Woods low—not an easy thing for a strong dollar man to note. Certainly, there is a risk that downward economic momentum will emerge. I worry about the plight of the big, populous states like Florida and California under the crush of the housing implosion. I take note of the reports from UPS, the rails, and the truckers as to the deceleration in year-over-year trends in pre-holiday shipments. I realize that Wal-Mart same-store growth has slowed, that mall traffic is down, and so on. But not a single one of my thirty-five CEO interlocutors, except for the homebuilders, felt that the economy was at risk of falling off the table. Fluor and the other big builders—or logistics organizers, as I like to call them—report a booming domestic infrastructure business, especially in the petrochemical sector. The technology folks, as manifested by the earnings reports of Microsoft, Apple, and others, continue to find that demand is brisk. Cisco’s CEO confirms that business with all but the financial institutions “has begun to flow again” after being laid low by the uncertainty of August. The airlines report volume conditions as “less bad” than they were in the third quarter. UPS’s CFO, about to become CEO, who serves on President Lockhart’s board, is concerned, like the rails, about consumer holiday demand, and notes that trans-Pacific shipments into the United States have slowed. Yet when he digs deep into the data, he will tell you that the tech side looks good. So the net effect is that, while nowhere near robust, “domestically, conditions have not materially worsened.” Except for housing and Bill’s two law firms, we are not hearing of significant lagging of receivables or collectibles. Many of my interlocutors, however, worry about prices, as do our staff members in Dallas. We differ significantly, Mr. Chairman, from the central assumption of the Greenbook in our views on headline inflation looking forward. I noticed you cocking an eye in my direction, Brian, when you were talking about the outliers. The Greenbook has a 3 percent number for PCE inflation for this year, followed by a deceleration, to a pace of 1.8 percent in 2008 and 1.7 in 2009. We in Dallas are not as confident that we will continue to experience a disinflation of the momentum of the PCE. Partly this stems from concerns expressed anecdotally by big importers like Wal-Mart, who report stiffening Chinese prices, by the CEO of JCPenney, who is planning for cost increases of goods imported from China on the order of 3 to 4 percent next year, and by the users of pulp and recycled waste paper that are set to announce a 5 percent increase in essential paper products effective in February, having just announced a double-digit increase not too long ago. Our concern at the Dallas Fed stems from two more-pervasive sources than that anecdotal evidence I just cited, and those are food and energy, for which we anticipate a more pernicious pass-through effect from recent rapid price increases of underlying commodities. The concern we have for food is encapsulated in the eye-popping chart on page II-30 of Part 2 of the Greenbook. You have to have a hawk’s eye to see this chart from that end of the table, but it shows an incredible divergence between food prices and the core PCE. Now this pattern has a historical precedent. A spread of this magnitude between food prices and core indexes occurred on several occasions between 1951 and 1980. In 1973, the gap was 20 percent. In 1974, the gap was closed when the CPI rose up accordingly. But we have not seen a gap of this nature in over a quarter-century. Wholesale food prices are up 6.3 percent for the year to date. Through September, the CPI for food is up 5.7 percent. As mentioned by one of the previous interlocutors, milk and green grocery prices are rising at double-digit paces. This goes beyond ethanol, Mr. Chairman, as a driver of shifts in crop rotation and production. It is occurring against a ramping up of the caloric intake of a few billion new eaters in China, India, and elsewhere. This is hardly encouraging, and it injects a modicum of doubt in predicting a significant decline in PCE inflation. We spoke about energy price dynamics earlier. They further cloud the picture. If you talk to Exxon or Independence, they will tell you that there is no problem in finding oil, in refining it, or in delivering the final product. They will, however, note that there are two key impulses at work. First, there is no evident slowdown in demand growth according to them— that is, domestically—and the appetite in the BRICs (Brazil, Russia, India, and China) and in the developing countries was described as voracious. An enormous amount of infrastructure in chemical plant capacity is being constructed everywhere, from the Gulf Coast of the United States to the Middle East to China and Singapore, in order to be nearer to either feedstock or growing final demand. Any analysis of the income elasticity of demand for oil in low but rising income nations like China and India points to demand for oil that will grow even faster than their slightly slower but still rapidly growing income levels. Second, price pressures on crude at the margin are compounded by noncommercial activity, which we did not talk about earlier. Noncommercial contracts, the busywork of what are called “city refiners” in the industry—that is, the city of London and the financial exchanges—have of late been running at triple their traditional volume according to Exxon’s CEO, driving oil through $90. Thus far, gasoline and distillates, which is where the pass-through rubber hits the consumer price road, have been tame in response. Bill discussed the low crack spread, for example. Yet our models at the Dallas Fed for retail gasoline prices envision increases above $3 a gallon next year if crude stays above $85, which we consider a reasonable probability. Similarly, price pressures for distillates are increasingly probable. Finally, while currently high inventories continue, it is noteworthy that natural gas prices have reversed their summer slide downward to $5.50 per million Btu and are now quoted at $7 at the Henry Hub. All this gives me, Mr. Chairman, a sense of discomfort, like that expressed by President Hoenig and President Plosser, on the headline inflation front and is a reminder that the balance of risk is not necessarily skewed only toward slower growth. Thank you, Mr. Chairman." CHRG-111shrg50814--207 RESPONSE TO WRITTEN QUESTIONS OF SENATOR JOHNSON FROM BEN S. BERNANKEQ.1. I am very concerned that the Fed's tools could become limited and less flexible, and that the Fed's ability to stimulate the economy given an effective zero interest rate is hindered. What role will the Fed play going forward in our economic recovery?A.1. The Federal Reserve does not lose its ability to provide macroeconomic stimulus when short-term interest rates are at zero. However, when rates are this low, monetary stimulus takes nontraditional forms. The Federal Reserve has announced many new programs over the past year-and-a-half to support the availability of credit and thus help buoy economic activity. These programs are helping to restore the flow of credit to banks, businesses, and consumers. They are also helping to keep long-term interest rates and mortgage rates at very low levels. The Federal Reserve will continue to use these tools as needed to help the economy recover and prevent inflation from falling to undesirably low levels.Q.2. As part of the White House's new housing plan, the administration suggests changes to the bankruptcy law to allow judicial modification of home mortgages. Do you believe ``cramdown'' could affect the value of mortgage backed securities and how they are rated? Will bank capital be impacted if ratings on securities change? Is it better for consumers to get a modification from their servicer or through bankruptcy?A.2. The Federal Reserve Board and other banking agencies have encouraged federally regulated institutions to work constructively with residential borrowers at risk of default and to consider loan modifications and other prudent workout arrangements that avoid unnecessary foreclosures. Loss mitigation techniques, including loan modifications, that preserve homeownership are generally less costly than foreclosure, particularly when applied before default. Such arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the financial institution and the borrower. (See Statement on Loss Mitigation Strategies for Servicers of Residential Mortgages, released by banking agencies on September 5, 2007.) Modifications in these contexts would be voluntary on the part of the servicer or holder of the loan. Although various proposals have circulated regarding so-called ``cramdown,'' the common theme of the proposals would permit judicial modification of the mortgage contract in circumstances where the borrower has filed for bankruptcy. These proposals present a number of challenging and potentially competing issues that should be carefully weighed. These issues include whether borrower negotiation with the servicer or loan holder is a precondition to judicial modification, the impact on risk assessment of the underlying obligation by holders of mortgage loans, and the appropriateness of permitting modification decisions by parties other than the holders of the loan or their servicers. Whether a borrower would be better off with a modification from a servicer or through bankruptcy would depend on many factors including the circumstances of the individual borrower, the terms of the modification, and the conditions governing any judicial modification in a bankruptcy proceeding. In general, when a depository institution is a holder of a security, the capital of the institution would likely be affected if the security is downgraded. How bankruptcy would impact the servicer would depend in part on the securitization documents treatment of the mortgage loans affected by bankruptcies under the relevant pooling and servicing agreements and the obligations of the servicer with respect to those loans. In addition, because the terms that might govern judicial modification in a bankruptcy proceeding have not been established, it is not clear how the value of mortgage-backed securities in general would be affected by changes to the bankruptcy laws that would permit judicial modification of mortgages.Q.3. There is pressure to move quickly and reform our financial regulatory structure. What areas should we address in the near future and which areas should we set aside until we realize the full cost of the economic fallout we are currently experiencing?A.3. The experience over the past 2 years highlights the dangers that systemic risks may pose not only to financial institutions and markets, but also for workers, households, and non-financial Businesses. Accordingly, addressing systemic risk and the related problem of financial institutions that are too big to fail should receive priority attention from policymakers. In doing so, policymakers must pursue a multifaceted strategy that involves oversight of the financial system as a whole, and not just its individual components, in order to improve the resiliency of the system to potential systemic shocks. This strategy should, among other things, ensure a robust framework for consolidated supervision of all systemically important financial firms organized as holding companies. The current financial crisis has highlighted that risks to the financial system can arise not only in the banking sector, but also from the activities of financial firms, such as insurance firms and investment banks, that traditionally have not been subject to the type of consolidated supervision applied to bank holding companies. Broad-based application of the principle of consolidated supervision would also serve to eliminate gaps in oversight that would otherwise allow risk-taking to migrate from more-regulated to less-regulated sectors. In addition, a critical component of an agenda to address systemic risk and the too-big-to-fail problem is the development of a framework that allows the orderly resolution of a systemically important nonbank financial firm and includes a mechanism to cover the costs of such a resolution. In most cases, the Federal bankruptcy laws provide an appropriate framework for the resolution of nonbank financial institutions. However, the bankruptcy laws do not sufficiently protect the public's strong interest in ensuring the orderly resolution of nondepository financial institutions when a failure would pose substantial systemic risks. Besides reducing the potential for systemic spillover effects in case of a failure, improved resolution procedures for systemically important firms would help reduce the too-big-to-fail problem by narrowing the range of circumstances that might be expected to prompt government intervention to keep a firm operating. Policymakers and experts also should carefully review whether improvements can be made to the existing bankruptcy framework that would allow for a faster and more orderly resolution of financial firms generally. Such improvements could reduce the likelihood that the new alternative regime would need to be invoked or government assistance provided in a particular instance to protect financial stability and, thereby, could promote market discipline. Another component of an agenda to address systemic risks involves improvements in the financial infrastructure that supports key financial markets. The Federal Reserve, working in conjunction with the President's Working Group on Financial Markets, has been pursuing several initiatives designed to improve the functioning of the infrastructure supporting credit default swaps, other OTC derivatives, and tri-party repurchase agreements. Even with these initiatives, the Board believes additional statutory authority is needed to address the potential for systemic risk in payment and settlement systems. Currently, the Federal Reserve relies on a patchwork of authorities, largely derived from our role as a banking supervisor, as well as on moral suasion to help ensure that critical payment and settlement systems have the necessary procedures and controls in place to manage their risks. By contrast, many major central banks around the world have an explicit statutory basis for their oversight of these systems. Given how important robust payment and settlement systems are to financial stability, and the functional similarities between many such systems, a good case can be made for granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems. The Federal Reserve has significant expertise regarding the risks and appropriate risk-management practices at payment and settlement systems, substantial direct experience with the measures necessary for the safe and sound operation of such systems, and established working relationships with other central banks and regulators that we have used to promote the development of strong and internationally accepted risk management standards for the full range of these systems. Providing such authority would help ensure that these critical systems are held to consistent and high prudential standards aimed at mitigating systemic risk. Financial stability could be further enhanced by a more explicitly macroprudential approach to financial regulation and supervision in the United States. Macroprudential policies focus on risks to the financial system as a whole. Such risks may be crosscutting, affecting a number of firms and markets, or they may be concentrated in a few key areas. A macroprudential approach would complement and build on the current regulatory and supervisory structure, in which the primary focus is the safety and soundness of individual institutions and markets. One way to integrate a more macroprudential element into the U.S. supervisory and regulatory structure would be for the Congress to direct and empower a governmental authority to monitor, assess, and, if necessary, address potential systemic risks within the financial system. Such a systemic risk authority could, for example, be charged with (1) monitoring large or rapidly increasing exposures--such as to subprime mortgages--across firms and markets; (2) assessing the potential for deficiencies in evolving risk-management practices, broad-based increases in financial leverage, or changes in financial markets or products to increase systemic risks; (3) analyzing possible spillovers between financial firms or between firms and markets, for example through the mutual exposures of highly interconnected firms; (4) identifying possible regulatory gaps, including gaps in the protection of consumers and investors, that pose risks for the system as a whole; and (5) issuing periodic reports on the stability of the U.S. financial system, in order both to disseminate its own views and to elicit the considered views of others. A systemic risk authority likely would also need an appropriately calibrated ability to take measures to address identified systemic risks--in coordination with other supervisors, when possible, or independently, if necessary. The role of a systemic risk authority in the setting of standards for capital, liquidity, and risk-management practices for the financial sector also would need to be explored, given that these standards have both microprudential and macroprudential implications.Q.4. How should the government and regulators look to mitigate the systemic risks posed by large interconnected financial companies? Do we risk distorting the market by identifying certain institutions as systemically important? Should the Federal Reserve step into the role as a systemic regulator or should this task be given to a different entity.A.4. As discussed in response to Question 3, I believe there are several important steps that should be part of any agenda to mitigate systemic risks and address the problem caused by institutions that are viewed as being too big to fail. Some of these actions--such as an improved resolution framework--would be focused on systemically important financial institutions, that is, institutions the failure of which would pose substantial risks to financial stability and economic conditions. A primary--though not the sole focus--of a systemic risk authority also likely would include such financial institutions. Publicly identifying a small set of financial institutions as ``systemically important'' would pose certain risks and challenges. Explicitly and publicly identifying certain institutions as systemically important likely would weaken market discipline for these firms and could encourage them to take excessive risks--tendencies that would have to be counter-acted by strong supervisory and regulatory policies. Similarly, absent countervailing policies, public designation of a small set of firms as systemically important could give the designated firms a competitive advantage relative to other firms because some potential customers might prefer to deal with firms that seem more likely to benefit from government support in times of stress. Of course, there also would be technical and policy issues associated with establishing the relevant criteria for identifying systemically important financial institutions especially given the broad range of activities, business models and structures of banking organizations, securities firms, insurance companies, and other financial institutions. Some commentators have proposed that the Federal Reserve take on the role of systemic risk authority; others have expressed concern that adding this responsibility might overburden the central bank. The extent to which this new responsibility might be a good match for the Federal Reserve depends a great deal on precisely how the Congress defines the role and responsibilities of the authority, as well as on how the necessary resources and expertise complement those employed by the Federal Reserve in the pursuit of its long-established core missions. As a practical matter, effectively identifying and addressing systemic risks would seem to require the involvement of the Federal Reserve in some capacity, even if not in the lead role. The Federal Reserve traditionally has played a key role in the government's response to financial crises because it serves as liquidity provider of last resort and has the broad expertise derived from its wide range of activities, including its role as umbrella supervisor for bank and financial holding companies and its active monitoring of capital markets in support of its monetary policy and financial stability objectives.Q.5. The largest individual corporate bailout to date has not been a commercial bank, but an insurance company. What steps has the Federal Reserve taken to make sure AIG is not perceived as being guaranteed by the Federal government?A.5. In light of the importance of the American International Group, Inc (AIG) to the stability of financial markets in the recent deterioration of financial markets and continued market turbulence generally, the Treasury and the Federal Reserve have stated their commitment to the orderly restructuring of the company and to work with AIG to maintain its ability to meet its obligations as they come due. In periodic reports to Congress submitted under section 129 of the Emergency Economic Stabilization Act of 2008, in public reports providing details on the Federal Reserve financial statements, and in testimony before Congress and other public statements, we have described in detail our relationship to AIG, which is that of a secured lender to the company and to certain special purpose vehicles related to the company. These disclosures include the essential terms of the credit extension, the amount of AIG's repayment obligation, and the fact that the Federal Reserve's exposure to AIG will be repaid through the proceeds of the company's disposition of many of its subsidiaries. Neither the Federal Reserve, nor the Treasury, which has purchased and committed to purchase preferred stock issued by AIG, has guaranteed AIG's obligations to its customers and counterparties. Moreover, the Government Accountability Office has inquired into whether Federal financial assistance has allowed AIG to charge prices for property and casualty insurance products that are inadequate to cover the risk assumed. Although the GAO has not drawn any final conclusions about how financial assistance to AIG has impacted the overall competitiveness of the property and casualty insurance market, the GAO reported that the state insurance regulators the GAO spoke with said they had seen no indications of inadequate pricing by AIG's commercial property and casualty insurers. The Pennsylvania Insurance Department separately reported that it had not seen any clear evidence of under-pricing of insurance products by AIG to date.Q.6. Given the critical role of insurers in enabling credit transactions and insuring against every kind of potential loss, and the size and complexity of many insurance companies, do you believe that we can undertake serious market reform without establishing federal regulation of the insurance industry?A.6. As noted above, ensuring that all systemically important financial institutions are subject to a robust framework--both in law and practice--for consolidated supervision is an important component of an agenda to address systemic risks and the too-big-to-fail problem. While the issue of a Federal charter for insurance is a complex one, it could be useful to create a Federal option for insurance companies, particularly for large, systemically important insurance companies.Q.7. What effect do you believe the new Fed rules for credit cards will have on the consumer and on the credit card industry?A.7. The final credit card rules are intended to allow consumers to access credit on terms that are fair and more easily understood. The rules seek to promote responsible use of credit cards through greater transparency in credit card pricing, including the elimination of pricing practices that are deceptive or unfair. Greater transparency will enhance competition in the marketplace and improve consumers' ability to find products that meet their needs From the perspective of credit card issuers, reduced reliance on penalty rate increases should spur efforts to improve upfront underwriting. While the Board cannot predict how issuers will respond, it is possible that some consumers will receive less credit than they do today. However, these rules will benefit consumers overall because they will be able to rely on the rates stated by the issuer and can therefore make informed decisions regarding the use of credit.Q.8. The Fed's new credit card rules are not effective until July 2010. We have heard from some that this is too long and that legislation needs to be passed now to shorten this to a few months. Why did the Fed give the industry 18 months put the rules in place?A.8. The final rules represent the most comprehensive and sweeping reforms ever adopted by the Board for credit card accounts and will apply to more than 1 billion accounts. Given the breadth of the changes, which affect most aspects of credit card lending, card issuers must be afforded ample time for implementation to allow for an orderly transition that avoids unintended consequences, compliance difficulties, and potential liabilities. To comply with the final rules, card issuers must adopt different business models and pricing strategies and then develop new credit products. Depending on how business models evolve, card issuers may need to restructure their funding mechanisms. In addition to these operational changes, issuers must revise their marketing materials, application and solicitation disclosures, credit agreements, and periodic statements so that the documents reflect the new products and conform to the rules. Changes to the issuers' business practices and disclosures will involve extensive reprogramming of automated systems which subsequently must be tested for compliance, and personnel must receive appropriate training. Although the Board has encouraged card issuers to make the necessary changes as soon as practicable, an 18-month compliance period is consistent with the nature and scope of the required changes. ------ CHRG-111hhrg53244--282 Mr. Adler," Thank you, Mr. Chairman. First, I want to commend you. I think your work with TALF in particular has been ingenious, I think very, very helpful in creating markets where there was an absence of credit. So I really give you enormous credit for trying to provide credit through the Federal Government. I know you have spoken with a couple of members this morning about Federal spending and the potential looming threat it poses to our economy longer term. I am hearing from many of my constituents in Ocean County, New Jersey, that they are very greatly concerned about that spending pattern, the trajectory of spending we are on as a country, and that it may create deficits and Federal debt that is sustainable long term, that raises interest rates inevitably as the cost of government financing becomes unbearable. Can you revisit this topic with me? I know you have talked to some other people about it, but maybe you could allay my concerns that it is not a looming crisis facing our country. " CHRG-111shrg52619--212 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM GEORGE REYNOLDSQ.1. The convergence of financial services providers and financial products has increased over the past decade. Financial products and companies may have insurance, banking, securities, and futures components. One example of this convergence is AIG. Is the creation of a systemic risk regulator the best method to fill in the gaps and weaknesses that AIG has exposed, or does Congress need to reevaluate the weaknesses of federal and state functional regulation for large, interconnected, and large firms like AIG?A.1. NASCUS \1\ members do not have oversight responsibilities for AIG. The answers provided by NASCUS focus on issues related to our expertise regulating state credit unions and issues concerning the state credit union system. Although NASCUS does not have specific comments related to AIG, the following views on systemic risk are provided for your consideration.--------------------------------------------------------------------------- \1\ NASCUS is the professional association of state credit union regulatory agencies that charter, examine and supervise the nation's 3,100 state-chartered credit unions.--------------------------------------------------------------------------- It is important that systemic risk that is outside of the normal supervisory focus of financial institution regulators be monitored and controlled, but it is also imperative that the systemic risk process not interfere or add additional regulatory burden to financial institutions that are already supervised by their chartering authorities (state and federal) and their deposit insurers. Regarding systemic risk, NASCUS believes that systemic risk and concentration risk can be mitigated through state and federal regulation cooperation. Regardless of which approach is selected to mitigate systemic risk, it presents all regulators with challenges, even those without direct jurisdiction over the entity representing the risk. By drawing on the expertise of many regulatory agencies, state and federal regulators could improve their ability to detect and address situations before they achieve critical mass. State regulators play an important role in mitigating systemic risk in the state credit union system. Congress provides and affirms this distinct role in the Federal Credit Union Act (FCUA) by providing a system of ``consultation and cooperation'' between state and federal regulators. \2\ It is imperative that any regulatory structure preserve state regulators role in overseeing and writing regulations for state credit unions. In addition, it is critical that state regulators and NCUA have parity and comparable systemic risk authority with the Federal Deposit Insurance Corporation (FDIC). NASCUS would be concerned about systemic risk regulation that introduces a new layer of regulation for credit unions or proposes to consolidate regulators and state and federal credit union charters.--------------------------------------------------------------------------- \2\ The Consultation and Cooperation With State Credit Union Supervisors provision contained in The Federal Credit Union Act, 12 U.S. Code 1757a(e) and 12 U.S. Code 1790d(l).Q.2. Recently there have been several proposals to consider for financial services conglomerates. One approach would be to move away from functional regulation to some type of single consolidated regulator like the Financial Services Authority model. Another approach is to follow the Group of 30 Report which attempts to modernize functional regulation and limit activities to address gaps and weaknesses. An in-between approach would be to move to an objectives-based regulation system suggested in the Treasury Blueprint. What are some of ---------------------------------------------------------------------------the pluses and minuses of these three approaches?A.2. The Treasury Blueprint for a Modernized Financial Regulatory Structure, presented in March 2008, suggests an objectives-based approach to address market failures. NASCUS opposes this approach because it does not recognize the supervisory, enforcement and rule-making authority of the states. The suggested prudential financial regulator usurps the role of the National Credit Union Administration (NCUA) and it eliminates the National Credit Union Share Insurance Fund (NCUSIF), a fund that federally insured credit unions recapitalized in 1985 by depositing one percent of their shares into the Share Insurance Fund. The Blueprint would eliminate the credit union dual chartering system, a system that is based on the important foundation of competition and choice between state and federal charters. Disruption of the current dual chartering structure would have various negative impacts. It would diminish state and federal regulator cooperation, tip the balance of power between states and the federal government and minimize the economic benefit and enhanced consumer protections available to states through state-chartered institutions. State legislators and regulators would no longer determine what is appropriate for a state-chartered institution.Q.3. If there are institutions that are too big to fail, how do we identify that? How do we define the circumstance where a single company is so systemically significant to the rest of our financial circumstances and our economy that we must not allow it to fail?A.3. While relatively few credit unions fall into the category of ``too big to fail,'' with the exception of perhaps some of the larger corporate credit unions, I believe as a general rule that if an institution is ``too big to fail,'' then perhaps it is also too large to exist. Perhaps the answer is to functionally separate and decouple the risk areas of a ``too big to fail'' organization so that a component area can have the market discipline of potential failure, without impairing the entire organization. Financial institutions backed by federal deposit insurance need to have increased expectations of risk control and risk management. Clearly it is important to take steps to reduce systemic risk and lessen the impact of ``too big to fail.'' Many of the credit unions that I supervise in Georgia would argue that the result of having these large institutions with systemic risk is that when problems arise, they get passed on to smaller credit unions through increased deposit insurance assessments.Q.4. We need to have a better idea of what this notion of too big to fail is--what it means in different aspects of our industry and what our proper response to it should be. How should the federal government approach large, multinational, and systemically significant companies?A.4. See response to previous question above.Q.5. What does ``fail'' mean? In the context of AIG, we are talking about whether we should have allowed an orderly Chapter 11 bankruptcy proceeding to proceed. Is that failure?A.5. While AIG does not directly relate to the state-chartered credit unions supervised by NASCUS state regulators, my general view as a financial services regulator is that institutions which become insolvent should face market based solutions; either bankruptcy or some type of corporate reorganization. Seeking government based solutions under these circumstances encourages excessive risk taking and creates moral hazard. ------ FOMC20080805meeting--17 15,MR. BULLARD.," Thank you, Mr. Chairman. I'm just following up here. I mean, as much as I love exhibits 14, 15, and 16--and I have used a lot of them myself when I talk about the economy--it is not really appropriate to look at these as measures of stress. You could just say that these are the equilibrium prices in an economy that is adjusting to a big shock. You could have a completely flat line here that would indicate stress in markets because these prices aren't moving around appropriately to the risks that have developed and opened up. So a lot of the concern around the table has been exactly that, when markets freeze up, you can't do any trade at any price; and for that the volume data would seem to be a much better indicator of the kinds of things that we are worried about. I think that this is conditioning a lot of our thinking about the economy--you look at this picture, and you naturally think it has to go back to 10 basis points before the crisis is over. That probably is not going to happen anytime soon and maybe never. Thanks. " FOMC20060808meeting--147 145,CHAIRMAN BERNANKE.," Okay. Thank you. Let me just say that I think this language is purely descriptive. I don’t think it’s conditioning our action on anything having to do with housing. I don’t think the market will tie our move to housing. Let’s just take a straw vote. How many would like to keep the statement as it is with housing included? One, two, three, four, five, six, seven, eight, nine, ten, eleven. Okay. I think that’s a majority. So we’ll leave section 2 as it is. Is there any sentiment for going back to alternative A, section 3, second sentence, which includes ongoing productivity gains? Are any of you in favor of that? [Laughter] All right. The statement, then, will be exactly alternative B, except that the third section of alternative C will be substituted for the third section of alternative B. Would you please call the roll?" FOMC20070131meeting--324 322,MR. REINHART.," Exhibit 5 presents a decision tree outlining the possible paths you might take in incorporating an economic forecast in the policymaking process. I am including this schematic because, among other reasons, it is just what you would expect from me. [Laughter] Before we trace out some of those limbs, I want to remind you why the economic forecast is on today’s agenda. Discussion of monetary policy, both here and abroad, has increasingly focused on the forward-looking nature of setting policy. For the Federal Reserve, the structure of the current process of releasing an economic projection was set almost thirty years ago by improvisation in response to congressional prodding. Is it possible that the Committee could arrive at a more coherent way of producing and releasing a forecast that would enable policymakers to describe better what they do? The possibilities for producing and releasing a forecast are laid out at the top of the exhibit. Note that a couple of the nodes correspond to questions from the subcommittee to you in a memo I distributed on Friday. In particular, as flagged by the “1” in the decision tree and repeated in the list below, “Does the Committee want to produce a joint forecast or conduct a survey of individual forecasts?” The answer to this question is both hard—because it has considerable implications for your time and resources in the System more generally—and easy to predict—at least based on conversations I’ve had with many of you and your staff. To make it even easier to answer, let me paraphrase those conversations: “Do you want to change the basic nature of the Committee process by adding multiple rounds of meetings so as to enforce a more uniform view of the outlook than has ever existed before, or do you want to modify the status quo?” [Laughter] If you prefer to continue the practice of providing individual forecasts, you might want to reexamine the extent of coordination in that process. That is item 2 at the top and bottom, “If the forecasts are done individually, should they be based on common assumptions about some key conditioning factors?” Chief among those factors is the path of monetary policy. Do you want to continue with each taking your own view of monetary policy, settle on some joint assumption, or use market-based quotes? The individual entries in a numerical forecast have only limited usefulness in describing the economic outlook and the backdrop for setting policy. Rather, the narrative thread explaining the forecast is the most useful because it allows the reader to assess the credibility of the projection, to position his or her own view when there is a difference of opinion, and to gauge potential risks to the outlook. As posed in question 3, do you want to accompany a forecast with a minutes-style narrative description? As with the minutes—and noted in question 4—this document could be circulated for comments from meeting participants and ultimately be approved by the Committee through a notation vote. Such a procedure, however, will extend the interval between the making of the forecast and its release, raising the number of times that inconvenient data releases will render the projection moot. If you want a more timely release, drafting and releasing such a minutes-style document could be delegated to either the Chairman or the staff. The last four questions cover technical attributes of a forecast. In particular, as noted in question 5, how frequently should forecasts be made? The current semiannual reporting cycle was set by the Congress, but it means that the published forecasts become stale. Another inconvenience with the current setup is that an annual forecast made in June incorporates an implicit forecast of the second half. Would you rather be explicit and forecast half years? More generally, as in item 6, how many years should the forecast cover? Seventh, how many variables should be forecast, and which should they be? Nominal income, for example, remains on the survey by historical accident—from the days when the velocity of money was thought to be predictable and knowing your expectation about income growth would help in setting a monetary range. Are there other variables that would be more helpful? Finally, should there be some attempt to convey numerically the uncertainty surrounding the forecasts? Relaying such information would more accurately convey the balancing of risks that is an integral part in your deliberations and would remind your readers that it is a projection, not a promise. By now, we probably have your heads spinning with all the possible permutations of the many decisions that could be made. With this many moving parts, the problem is complicated. But not all the issues to be resolved are hard. First, you have the force of precedent, which is a powerful attractor within the Federal Reserve System. That is why I wouldn’t worry for a minute about whether the forecast and its description should reflect the views of the Committee or all meeting participants. The precedents of the outlook portion of the minutes and the semiannual survey of forecasts establish that any release should reflect everyone’s views. Second, for the sake of consistency, some of the decisions about the format of the forecast will be driven by other decisions you may make later. For instance, if in your deliberations about quantifying the price objective in March you indicate a preference for measuring inflation in terms of CPI or PCE, whether headline or core, the variable sampled in your survey should be a good indicator of that goal. If you can answer the hard questions today—eight of which the subcommittee sent to you—then it would be possible to frame out a rough structure of a specific proposal. Detail could be filled in by surveying you later on technical matters, and sometime thereafter you could get a formal proposal for consideration as part of the general package of work on communication. That concludes our prepared remarks." FOMC20071031meeting--19 17,MR. STOCKTON.," Well, I should get the facts before I answer your question in terms of exactly how this compares with both the 2000 period and the 1990 period. We could certainly do that and circulate it to the Committee. Obviously, in our forecast we have credit growth decelerating not just because overall activity is decelerating but because we think there will be some important restraints on credit availability going forward. Most of that, of course, is on the mortgage side, but some of it is on the business credit side as well. That said, we are not forecasting a deep credit crunch. If you were more concerned that that was what you were facing, I don’t think this forecast is consistent with it. This forecast is consistent with some unusual restraint on the availability of credit, principally on the mortgage side but more broadly elsewhere, but not truly a deep or strong headwind type of episode in which there is substantial impairment going forward. As I noted at the last meeting, even the restraint that we do have on the credit side fades over the coming year." CHRG-110hhrg44903--127 Mr. McHenry," Thank you, Mr. Chairman. This question is to Chairman Cox. There is wide agreement that the credit rating agencies need to be reformed, and there needs to be reform instituted by them as well. Your rulemaking goes a long way towards that end to resolve some conflicts of interest and create some greater transparency within the credit rating agencies so the market can truly know what is happening. And I believe we need to ensure that issuers and originators are providing credit rating agencies with adequate information on assets underlying a structured security. So does the SEC currently have the authority to ensure that originators and issuers are providing NRSROs the information they need to rate structured securities? " CHRG-111shrg57320--207 Mr. Dochow," They are smaller in dollars. They are large in volumes. And the credit score, their credit reports, their loan-to-value ratios were historically the most predictive of ability to pay and those loans' performance. Senator Kaufman. So why not just ask people what their income was and have some verification for it? That is the part I am having trouble with. I got all the rest of it. I mean, we could poll everybody in this room. I don't think anyone has ever gone in, outside of maybe if they were with WaMu or some of the other banks in California which did practice this, Mr. Reich, or this business as WaMu--I don't think anybody in this room has ever gone into a loan and they said, what is your income, and they said, OK, that is enough. I am going to check your FICO score and everything else, but you don't have to document where your income is coming from. You don't have to give me a W-2 form. You don't have to do anything else. I have credit cards, I have never seen that as an experience for me. And again, I realize it started in this industry, and I think maybe it started for a good reason. And as Mr. Reich said, I think everyone would say this is an anathema. A stated loan is anathema. I think that is what most people would say. I think the two regulators who were here earlier kind of went, wow. When the folks from the two risk managers that testified the other day were concerned about this and reported their concern to management. So I am trying to figure out--because every time something like this has come down over history, the standard answer you hear--well, everybody did it. Everybody did it. And when you hear that, that is when I get very scared because what are we going to do here in the Senate so that we deal with a concept that everybody did it is--we are a Nation of laws, not a Nation of everybody did it. Mr. Reich and Mr. Dochow, would you like to comment on my concern? " CHRG-111shrg56262--98 PREPARED STATEMENT OF WILLIAM W. IRVING Portfolio Manager, Fidelity Investments October 7, 2009 Good afternoon Chairman Reed, Ranking Member Bunning, and Members of the Subcommittee. I am Bill Irving, an employee of Fidelity Investments, \1\ where I manage a number of fixed-income portfolios and play a leading role in our investment process in residential mortgage-backed securities (RMBS). This experience has certainly shaped my perspective on the role of securitization in the financial crisis, the condition of the securitization markets today, and policy changes needed going forward. I thank you for the opportunity to share that perspective with you in this hearing. At the outset, I want to emphasize that the views I will be expressing are my own, and do not necessarily represent the views of my employer, Fidelity Investments.--------------------------------------------------------------------------- \1\ Fidelity Investments is one of the world's largest providers of financial services, with assets under Administration of $3.0 trillion, including assets under management of more than $1.4 trillion as of August 31, 2009. Fidelity offers investment management, retirement planning, brokerage, and human resources and benefits outsourcing services to over 20 million individuals and institutions as well as through 5,000 financial intermediary firms. The firm is the largest mutual fund company in the United States, the number one provider of workplace retirement savings plans, the largest mutual fund supermarket and a leading online brokerage firm. For more information about Fidelity Investments, visit Fidelity.com.---------------------------------------------------------------------------Summary I will make three main points. First, the securitized markets provide an important mechanism for bringing together investors and borrowers to provide credit to the American people for the financing of residential property, automobiles, and retail purchases. Securitization also provides a major source of funding for American businesses for commercial property, agricultural equipment, and small-business investment. My second point is that the rapid growth of the markets led to some poor securitization practices. For example, loan underwriting standards got too loose as the interests of issuers and investors became misaligned. Furthermore, liquidity was hindered by a proliferation of securities that were excessively complex and customized. My third and final point is that in spite of these demonstrated problems, the concept of asset securitization is not inherently flawed; with proper reforms to prevent weak practices, we can harness the full potential of the securitization markets to benefit the U.S. economy.Brief Review of the Financial Crisis To set context, I will begin with a brief review of the financial crisis. This view is necessarily retrospective; I do not mean to imply that investors, financial institutions or regulators understood all these dynamics at the time. In the middle of 2007, the end of the U.S. housing boom revealed serious deficiencies in the underwriting of many recently originated mortgages, including subprime loans, limited-documentation loans, and loans with exotic features like negative amortization. Many of these loans had been packaged into complex and opaque mortgage-backed securities (MBS) that were distributed around the world to investors, some of whom relied heavily on the opinion of the rating agencies and did not sufficiently appreciate the risks to which they were exposed. \2\--------------------------------------------------------------------------- \2\ At Fidelity, we consider the opinions of the rating agencies, but we also do independent credit research on each issuer or security we purchase.--------------------------------------------------------------------------- The problems of poorly understood risks in these complex securities were amplified by the leverage in the financial system. For example, in 2007, large U.S. investment banks had about $16 of net assets for each dollar of capital. \3\ Thus, a seemingly innocuous hiccup in the mortgage market in August 2007 had ripple effects that quickly led to a radical reassessment of what is an acceptable amount of leverage. What investors once deemed safe levels of capital and liquidity were suddenly considered far too thin. As a result, assets had to be sold to reduce leverage. This selling shrank the supply of new credit and raised borrowing costs. In fact, the selling of complex securities was more than the market could bear, resulting in joint problems of liquidity and solvency. Suddenly, a problem that had started on Wall Street spread to Main Street. Companies that were shut off from credit had to cancel investments, lay off employees and/or hoard cash. Many individuals who were delinquent on their mortgage could no longer sell their property at a gain or refinance; instead, they had to seek loan modifications or default.--------------------------------------------------------------------------- \3\ Source: SNL Financial, and company financials.--------------------------------------------------------------------------- This de-leveraging process created a vicious cycle. Inability to borrow created more defaults, which led to lower asset values, which caused more insolvency, which caused more de-leveraging, and so forth. Home foreclosures and credit-card delinquencies rose, and job layoffs increased, helping to create the worst recession since the Great Depression.Role Played by Asset Securitization in the Crisis Without a doubt, securitization played a role in this crisis. Most importantly, the ``originate-to-distribute'' model of credit provision seemed to spiral out of control. Under this model, intermediaries found a way to lend money profitably without worrying if the loans were paid back. The loan originator, the warehouse facilitator, the security designer, the credit rater, and the marketing and product-placement professionals all received a fee for their part in helping to create and distribute the securities. These fees were generally linked to the size of the transaction and most of them were paid up front. So long as there were willing buyers, this situation created enormous incentive to originate mortgage loans solely for the purpose of realizing that up-front intermediation profit. Common sense would suggest that securitized assets will perform better when originators, such as mortgage brokers and bankers, have an incentive to undertake careful underwriting. A recent study by the Federal Reserve Bank of Philadelphia supports this conjecture. \4\ The study found evidence that for prime mortgages, private-label securitized loans have worse credit performance than loans retained in bank portfolios. Specifically, the study found that for loans originated in 2006, the 2-year default rate on the securitized loans was on average 15 percent higher than on loans retained in bank portfolios. This observation does not necessarily mean that issuers should be required to retain a portion of their securities, but in some fashion, the interests of the issuers and the investors have to be kept aligned.--------------------------------------------------------------------------- \4\ Elul, Ronel, ``Working Paper No. 09-21 Securitization and Mortgage Default: Reputation vs. Adverse Selection'', Federal Reserve Bank of Philadelphia. September 22, 2009.--------------------------------------------------------------------------- Flawed security design also played a role in the crisis. In its simplest form, securitization involves two basic steps. First, many individual loans are bundled together into a reference pool. Second, the pool is cut up into a collection of securities, each having a distinct bundle of risks, including interest-rate risk, prepayment risk, and credit risk. For example, in a simple sequential structure, the most senior bond receives all available principal payments until it is retired; only then does the second most senior bond begin to receive principal; and so on. In the early days of securitization, the process was kept simple, and there were fewer problems. But over time, cash-flow rules grew increasingly complex and additional structuring was employed. For example, the securities from many simple structures were rebundled into a new reference pool, which could then be cut into a new set of securities. In theory, there is no limit to the amount of customization that is possible. The result was excessive complexity and customization. The complexity increased the challenge of determining relative value among securities, and the nonuniformity hurt liquidity when the financial system was stressed. One example of poor RMBS design is the proliferation of securities with complex rules on the allocation of principal between the senior and subordinate bonds. Such rules can lead to counter-intuitive outcomes in which senior bonds take write-downs while certain subordinate bonds are paid off in full. A second example of poor design is borrower ability to take out a second-lien mortgage without notifying the first-lien holder. This ability leads to a variety of thorny issues, one of which is simply the credit analysis of the borrower. If a corporation levered further, the senior unsecured debt holder would surely be notified, but that is not so in RMBS.Other Factors Contributing to the Crisis Securitization of assets played a role in the crisis, but there were several additional drivers. Low interest rates and a bubble mentality in the real estate market also contributed to the problem. Furthermore, in the case of securitized assets, there were plenty of willing buyers, many of them highly levered. In hindsight, this high demand put investors in the position of competing with each other, making it difficult for any of them to demand better underwriting, more disclosure, simpler product structures, or other favorable terms. Under-estimation of risk is always a possibility in capital markets, as the history of the stock market amply demonstrates. That possibility does not mean that capital markets, or asset securitization, should be discarded.Benefits of Asset Securitization When executed properly, there are many potential benefits of allowing financial intermediaries to sell the loans they originate into the broader capital markets via the securitization process. For one, this process provides loan originators much wider sources of funding than they could obtain through conventional sources like retail deposits. For example, I manage the Fidelity Ginnie Mae Fund, which has doubled in size in the past year to over $7 billion in assets; the MBS market effectively brings together shareholders in this Ginnie Mae Fund with individuals all over the country who want to purchase a home or refinance a mortgage. In this manner, securitization breaks down geographic barriers between lenders and borrowers, thereby improving the availability and cost of credit across regions. A second benefit of securitization is it generally provides term financing which matches assets against liabilities; this stands in contrast to the bank model, a substantial mismatch can exist between short-term retail deposits and long-term loans. Third, it expands the availability of credit across the country's socio-economic spectrum, and provides a mechanism through which higher credit risks can be mitigated with structural enhancements. Finally, it fosters competition among capital providers to ensure more efficient pricing of credit to borrowers.Current Conditions of Consumer ABS and Residential MBS Markets At present, the RMBS and ABS markets are sharply bifurcated. On one side are the sectors that have received Government support, including consumer ABS and Agency MBS (i.e., MBS guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae); these sectors are, for the most part, functioning well. On the other side are the sectors that have received little or no such support, such as the new-issue private-label RMBS market, which remains stressed, resulting in a lack of fresh mortgage capital for a large segment of the housing market.Consumer ABS The overall size of the consumer debt market is approximately $2.5 trillion; \5\ this total includes both revolving debt (i.e., credit-card loans) and nonrevolving debt (e.g., auto and student loans). Approximately 75 percent takes the form of loans on balance sheets of financial institutions, while the other 25 percent has been securitized. \6\--------------------------------------------------------------------------- \5\ Source: Federal Reserve, www.federalreserve.gov/releases/g19/current/g19.htm. \6\ Source: Federal Reserve, www.federalreserve.gov/releases/g19/current/g19.htm.--------------------------------------------------------------------------- From 2005 through the third quarter of 2008, auto and credit card ABS issuance ranged between $160 billion and $180 billion per year. \7\ However, after the collapse of Lehman Brothers in September 2008, new issuance came to a virtual halt. With the ABS market effectively shut down, lenders tightened credit standards to where only the most credit worthy borrowers had access to credit. As a result, the average interest rate on new-car loans provided by finance companies increased from 3.28 percent at end of July 2008 to 8.42 percent by the end of 2008. \8\--------------------------------------------------------------------------- \7\ Source: Bloomberg. \8\ Federal Reserve, www.federalreserve.gov/releases/g19/hist/cc_hist_tc.html.--------------------------------------------------------------------------- Issuance did not resume until March 2009 when the Term Asset-Backed Securities Loan Facility (TALF) program began. Thanks to TALF, between March and September of this year, there has been $91 billion of card and auto ABS issuance. \9\ Coincident with the resumption of a functioning auto ABS market, the new-car financing rate fell back into the 3 percent range and consumer access to auto credit has improved, although credit conditions are still more restrictive than prior to the crisis. While TALF successfully encouraged the funding of substantial volumes of credit card receivables in the ABS market, it is worth noting that credit card ABS issuance has recently been suspended due to market uncertainty regarding the future regulatory treatment of the sector.--------------------------------------------------------------------------- \9\ Source: Bloomberg.--------------------------------------------------------------------------- While interest rates on top tier New Issue ABS are no longer attractive for investors to utilize the TALF program, TALF is still serving a constructive role by allowing more difficult asset types to be financed through securitization. Examples include auto dealer floorplans, equipment loans to small businesses, retail credit cards, nonprime auto loans, and so forth.Residential MBS The overall size of the residential mortgage market is approximately $10.5 trillion, which can be decomposed into three main categories: 1. Loans on bank balance sheets: \10\ $3.5 trillion.--------------------------------------------------------------------------- \10\ Source: Federal Reserve, www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm. 2. Agency MBS: \11\ $5.2 trillion.--------------------------------------------------------------------------- \11\ Source: eMBS, www.embs.com.--------------------------------------------------------------------------- a. Fannie Mae: $2.7 trillion. b. Freddie Mac: $1.8 trillion. c. Ginnie Mae: $0.7 trillion. 3. Private-Label MBS: \12\ $1.9 trillion.--------------------------------------------------------------------------- \12\ Source: Loan Performance.--------------------------------------------------------------------------- a. Prime: $0.6 trillion. b. Alt-A: $0.8 trillion. c. Subprime: $0.5 trillion. Thanks to the extraordinary Government intervention over the past year, the Agency MBS market is performing very well. This intervention had two crucial components. First, on September 7, 2008, the director of the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship. This action helped reassure tens of thousands of investors in Agency unsecured debt and mortgage-backed securities that their investments were supported by the Federal Government, in spite of the sharp declines in home prices across the country. The second component of the Government intervention was the Federal Reserve's pledge to purchase $1.25 trillion of Agency MBS by the end of 2009. Year to date, as of the end of September 2009, the Fed had purchased $905 billion Agency MBS, while net supply was only $448 billion. \13\ Thus, the Fed has purchased roughly 200 percent of the year-to-date net supply. Naturally, this purchase program has reduced the spread between the yields on Agency MBS and Treasuries; we estimate the reduction to be roughly 50 basis points. As of this week, the conforming-balance \14\ 30-year fixed mortgage rate is approximately 4.85 percent, which is very close to a generational low. \15\--------------------------------------------------------------------------- \13\ Source: JPMorgan, ``Fact Sheet: Federal Reserve Agency Mortgage-Backed Securities Purchase Program''. \14\ As of 2009, for the contiguous States, the District of Columbia and Puerto Rico, the general conforming limit is $417,000; for high-cost areas, it can be as high as $729,500. \15\ Source: HSH Associates, Financial Publishers.--------------------------------------------------------------------------- In contrast, the new-issue private-label MBS market has received no Government support and is effectively shut down. From 2001 to 2006, issuance in this market had increased almost four-fold from $269 billion to $1,206 billion. \16\ But when the financial crisis hit, the issuance quickly fell to zero. Issuance in 2007, 2008 and 2009 has been $759 billion, $44 billion and $0, respectively. \17\ Virtually the only source of financing for mortgage above the conforming-loan limit (so-called ``Jumbo loans'') is a bank loan. As a result, for borrowers with high-credit quality, the Jumbo mortgage rate is about 1 percentage point higher than its conforming counterpart. \18\--------------------------------------------------------------------------- \16\ Source: Loan Performance. \17\ Source: Loan Performance. \18\ Source: HSH Associates, Financial Publishers.--------------------------------------------------------------------------- At first glance, the higher cost of Jumbo financing may not seem to be an issue that should concern policymakers, but what is bad for this part of the mortgage market may have implications for other sectors. If the cost of Jumbo financing puts downward pressure on the price of homes costing (say) $800,000, then quite likely there will be downward pressure on the price of homes costing $700,000, and so forth. Pretty soon, there is downward pressure on homes priced below the conforming limit. In my opinion, at the same time that policymakers deliberate the future of the Fannie Mae and Freddie Mac, they should consider the future of the mortgage financing in all price and credit-quality tiers.Recommended Legislative and Regulatory Changes The breakdown in the securitization process can be traced to four root causes: aggressive underwriting, overly complex securities, excessive leverage, and an over-reliance on the rating agencies by some investors. Such flaws in the process have contributed to the current financial crisis. However, when executed properly, securitization can be a very effective mechanism to channel capital into our economy to benefit the consumer and commercial sectors. Keep in mind that securitization began with the agency mortgage market, which has successfully provided affordable mortgage financing to millions of U.S. citizens for over 35 years. \19\ To ensure that the lapses of the recent past are not repeated, I recommend that regulatory and legislative efforts be concentrated in four key areas.--------------------------------------------------------------------------- \19\ Fannie Mae, Freddie Mac, and Ginnie Mae issued their first MBS in 1981, 1971, and 1970, respectively. Source: ``Fannie Mae and Freddie Mac: Analysis of Options for Revising the Housing Enterprises Long-term Structures'', GAO Report to Congressional Committees, September, 2009.--------------------------------------------------------------------------- First, promote improved disclosure to investors at the initial marketing of transactions as well as during the life of the deal. For example, originators should provide detailed disclosure on the collateral characteristics and on exceptions to stated underwriting procedures. Furthermore, there should be ample time before a deal is priced for investors to review and analyze a full prospectus, not just a term sheet. Second, strong credit underwriting standards are needed in the origination process. One way to support this goal is to discourage the up-front realization of issuers' profits. Instead, issuers' compensation should be aligned with the performance of the security over its full life. This issue is complex, and will likely require specialized rules, tailored to each market sector. Third, facilitate greater transparency of the methodology and assumptions used by the rating agencies to determine credit ratings. In particular, there should be public disclosure of the main assumptions behind rating methodologies and models. Furthermore, when those models change or errors are discovered, the market should be notified. Fourth, support simpler, more uniform capital structures in securitization deals. This goal may not readily be amenable to legislative action, but should be a focus of industry best practices. Taking such steps to correct the defects of recent securitization practices will restore much-needed confidence to this critical part of our capital markets, thereby providing improved liquidity and capital to foster continued growth in the U.S. economy. Additional Material Supplied for the Record Prepared Statement of the Mortgage Bankers Association The Mortgage Bankers Association (MBA) \1\ appreciates the opportunity to provide this statement for the record of the Senate Banking Securities, Insurance, and Investment Subcommittee hearing on the securitization of assets.--------------------------------------------------------------------------- \1\ The Mortgage Bankers Association (MBA) is the national association representing the real estate finance industry, an industry that employs more than 280,000 people in virtually every community in the country. Headquartered in Washington, DC, the association works to ensure the continued strength of the Nation's residential and commercial real estate markets; to expand homeownership and extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters professional excellence among real estate finance employees through a wide range of educational programs and a variety of publications. Its membership of over 2,400 companies includes all elements of real estate finance: mortgage companies, mortgage brokers, commercial banks, thrifts, Wall Street conduits, life insurance companies and others in the mortgage lending field. For additional information, visit MBA's Web site: www.mortgagebankers.org.--------------------------------------------------------------------------- Asset-backed securities are a fundamental component of the financial services system because they enable consumers and businesses to access funding, organize capital for new investment opportunities, and protect and hedge against risks. As policymakers evaluate securitization's role in the recent housing finance system's disruptions, MBA believes it is important to keep in mind the benefits associated with securitization when it is used prudently by market participants. Securitization describes the process in which relatively illiquid assets are packaged in a way that removes them from the institution's balance sheet and sold as more liquid securities. Securities backed by residential or commercial mortgages are an example of asset securitization. Securitization is an effective means of risk management for many institutions. For example, the accumulation of many loans in a single asset sector creates concentration risk on a financial institution's balance sheet. If that sector becomes distressed, these large concentrations could place the solvency of the financial institution at risk. However, securitization provides a remedy to avoid concentration risk by disbursing the exposure more widely across the portfolios of many investors. In this way, the exposure of any one investor is minimized. As demonstrated by the current business cycle however, if the entire system is hit by a significant systemic shock, all investors will face losses from these exposures, as diversification does not protect investors from systemic events. Securitization also enables various market sectors to create synergies by combining their particular areas of expertise. For example, community-based financial institutions are known for their proficiency in originating loans because of their relationships with local businesses and consumers, and their knowledge of local economic conditions. Securitization links these financial institutions to others that may be more adept at matching asset risks with investor appetites. As the last 2 or 3 years have demonstrated, when it is not understood, or poorly underwritten, securitization can cause meaningful harm to investors, lenders, borrowers and other segments of the financial services system. Since the economic and housing finance crisis began, investors have shunned securitization products, including mortgage-backed securities (MBS), particularly those issued by private entities. As a result, central banks and governments have taken up the slack with various programs to support securitization markets. MBA believes this has been an important, yet ultimately unsustainable, course of action. One key to the process is to create an environment where investors can accurately evaluate the risks in the various investment opportunities available to them, and have confidence that their analysis of the risk is consistent with what the underlying risk will turn out to be. No investments are risk-free. But reliable instruments allow responsible investors to evaluate whether the instrument's risk profile is within the boundaries of an investor's risk tolerance. When considering how to reestablish a safe and sound environment for securitization of real estate-related assets, MBA believes the following components must be addressed: Risk Assessment: Risk assessment is an imperfect science, but it is crucial for securitization to enable accurate, effective, and stable risk assessment. Equally important, third-party assessments of risk must be highly credible to be widely used or adopted. Aligning Risks, Rewards, and Penalties: A key consideration for the market going forward will be ensuring the alignment of risks with rewards and penalties. Loan attributes, such as whether a loan is adjustable-rate or fixed rate, or does or does not have a prepayment restriction, shift risks between the borrower and the investors. If investors or other market participants are not accountable for the risks they take on, they are prone to act irresponsibly by taking on greater risks than they otherwise would. Aligning Rewards With Long-Term Performance: Given the long-term nature of a mortgage contract, as well as the imperfect state of risk assessment, some risks inherent in a mortgage asset may not appear for some time after the asset has changed hands. It is important to consider the degree to which participants in the mortgage process can be held accountable for the long-term performance of an asset. Ensuring Capital Adequacy of Participants: Participants throughout the market need adequate levels of capital to protect against losses. Capital adequacy is keenly dependent on the assessment of risks outlined above. The greater the risks, as assessed, the greater the capital needed. In times of rapid market deterioration, when model and risk assumptions change dramatically, capital needs may change dramatically as well. If market participants that have taken on certain risks become undercapitalized, they may not be able to absorb those risks when necessary--forcing others to take on unanticipated risks and losses. Controlling Fraud Between Parties in the System: A key consideration for effective securitization is the degree to which fraud can be minimized. Key considerations include the ability to identify and prosecute fraud, and the degree to which fraud is deterred. Transparency: In order to attract investors, another key consideration for securitization is transparency. The less transparent a market is, the more poorly understood it will be by investors, and the higher will be the yield those investors demand to compensate for the uncertainty. The task of improving transparency and accountability involves both policy and operational issues. Public debate typically focuses on the policy issues--what general types of information should be disclosed, and who should share and receive this information. However, the operational issues are equally important to establishing and implementing a functional system that promotes and supports the goals of transparency and accountability. We are submitting testimony today to stress the importance to market transparency and investor confidence of better loan tracking and more accessible, complete, and reliable loan and security data across the primary and secondary mortgage markets.Loan and Security Tracking Improving transparency in the real estate finance system is considered essential to restoring investor confidence in the securitization market. Because the real estate finance system embraces multiple parties--loan originators, loan aggregators (servicers) and securitizers--we need transparency solutions that flow from and span the complete mortgage value chain. The goal, we think, is relatively easy to state: key information about mortgages, the securities built upon those mortgages, and the people and companies that create them, should all be linked and tracked over time, so our financial system is more transparent and the strengths and risks of various products can be properly assessed and appreciated. Loans need to be tracked, for example, to help identify fraud and distinguish the performance of various mortgage products and securities types. Just as the vehicle identification number, or ``VIN,'' has evolved from a simple serial number into a valuable tool for consumers, enabling a potential purchaser to research the history of any car or truck, a comprehensive mortgage/security numbering system would be the key to tracking MBS history and performance. Achieving such a goal is very doable because the essential components are already in place. With relatively minor modifications these existing systems can evolve into the tools necessary to meet the challenge of transparency and accountability. On the mortgage end of the value chain there is MERS. \2\ This national loan registry is already used by virtually all mortgage originators, aggregators, and securitizers to track individual mortgages by means of a unique, 18-digit Mortgage Identification Number, or ``MIN.'' For each registered mortgage, the MIN and the MERS database tracks information regarding the originator, the borrower, the property, the loan servicer, the investors, and any changes of ownership for the life of the loan. MERS currently tracks more than 60 million loans and is embedded in every major loan origination system, servicing system, and delivery system in the United States, so total adoption would be swift and inexpensive.--------------------------------------------------------------------------- \2\ ``MERS'' is formally known as MERSCORP, Inc., and is the owner and operator of the MERS System. MBA, along with Fannie Mae, Freddie Mac, and other industry participants, is a shareholder in MERS.--------------------------------------------------------------------------- On the securitization end of the value chain, the American Bankers Association has a product called CUSIP that generates a 9-digit identification number for most types of securities, including MBS. The CUSIP number uniquely identifies the company or issuer and the type of security instrument. Together, these two identifiers solve the loan and security tracking problem, with the MIN tracking millions of individual mortgage loans and the CUSIP tracking thousands of unique financial instruments created each year in the United States. Loan-level information for every mortgage and mortgage-backed security would be available at the touch of a button, for example, the credit rating agencies would have needed information to assess more accurately the risk of a given security and track its performance relative to other securities over time. As the Congress looks to reform the capital markets, it should require that these two complementary identification systems be linked and that they be expanded in scope to track the decisions of all market participants--originators, aggregators and securitizers. In this way, throughout the value chain, participants that contributed to the creation of high-risk mortgages and selling of high-risk securities may be identified and held accountable. With a system like this in place, the Congress, regulators and the market as a whole would have a means of distinguishing with much more precision the quality of financial products and could enforce the discipline that has not been previously possible.Data Standards The Mortgage Industry Standards Maintenance Organization, Inc. (``MISMO'') \3\ has been engaged for the past 8 years in developing electronic data standards for the commercial and residential real estate finance industries. These standards, which have been developed through a structured consensus-building process, are grounded in the following principles that we believe characterize a robust, transparent system of data reporting:--------------------------------------------------------------------------- \3\ MISMO is a wholly owned subsidiary of the Mortgage Bankers Association. First, there must be concrete definitions of the data elements that are going to be collected, and these definitions must be common across all the related products in the market. Different products (such as conforming and nonconforming loans) may require different data elements, but any data elements that are required for both products should have the same --------------------------------------------------------------------------- definitions. Second, there should be a standardized electronic reporting format by which these data elements are shared across the mortgage and security value chain and with investors. The standards should be designed so that information can freely flow across operating systems and programs with a minimum of reformatting or rekeying of data to facilitate desired analytics. Rekeying results in errors, undermining the reliability of data. MISMO's standards are written in the XML (Web based) computer language. This is the language used in the relaunch earlier this week of the Federal Register's Web site. As reported in The Washington Post on October 5, 2009, this Web site has been received with great praise for allowing researchers and other users to extract information readily from the Register for further analysis and reuse without rekeying. Mortgage and securities data transmitted using MISMO's data standards can similarly be extracted and used by investors and regulators for customized analytics. XML is also related to and compatible with the XBRL web language that the Securities and Exchange Commission (SEC) is implementing for financial reporting. Third, the definitions and the standards should be nonproprietary and available on a royalty-free basis, so that third-parties can easily access and incorporate those standards into their work, whether it be in the form of a new loan origination software package or an improved analytical tool for assessing loan and security performance or fraud detection. Fourth, to the extent that the data includes nonpublic personal information, the system must maintain the highest degree of confidentiality and protect the privacy of that information. True transparency requires that information is not only available, but also understandable and usable. The incorporation of these four principles into any new data reporting regime will help ensure that the goal of transparency and accountability is realized. We believe that the standards of MISMO and MERS satisfy these elements for the conforming mortgage market. Their relative positions in the real estate finance process provide them with unique insight and an objective perspective that we believe could be very useful to improving transparency and accountability in the nonconforming market. Increasing the quality and transparency of loan-level mortgage and MBS-related data is an essential step so that investor confidence may be restored and the risk of a similar securitization crisis of the kind we are experiencing in the future can be minimized. This objective is paramount to all market participants, and as such all participants have an interest in achieving a solution. However, because it is so critical, the ultimate solution must also be able to withstand the scrutiny of investors, Government regulators, and academics. It must be widely perceived as a fair, appropriate, and comprehensive response to the challenges at hand. In conclusion, MBA reiterates its request for Congress and other policymakers to be mindful of the important role of securitization to housing finance and the entire financial services system. As the Congress looks to reform the capital markets, we look forward to working with you to developing a framework with a solid foundation based on the key considerations outlined above." CHRG-111hhrg48867--265 Mr. Grayson," Thank you, Mr. Chairman. Gentlemen, if you were interested in increasing lending at a time when the general perception is that credit is in short supply and that we need to expand credit in order to keep the economy afloat, and you had a choice, and that choice was between bailing out huge institutions that have proven that they were not good at allocating credit by the fact that they lost billions upon billions of dollars versus providing additional credit or even relaxing reserve requirements for healthy institutions that had shown they could take that money and make a profit with it, which would you choose? Mr. Silvers? " CHRG-110shrg50417--77 Mr. Palm," The reopening of a market for asset-backed securities of whatever type, whether you are talking about the credit cards area or whether you are talking about, you know, simply mortgages themselves, because it is quite clear that, you know, the banks at this table themselves do not have the capital for those who are in the business to extend all home loans that are actually necessary in this country; and those markets have to be open. Having said that, you know, we read yesterday that announcement, too, and we are not aware of any of the details yet or exactly how it would work. But it certainly is something that really has to be explored because the capital necessary to support the extension of credit, whether it is consumer credit, whether it is credit to businesses, whether it is credit to homeowners through mortgages, in essence, has to be supported by a much broader range of investors as opposed to just bank deposits, for example. So we have to do something to reopen those markets, which, as you know, have been almost totally shut. Senator Crapo. Yes. Thank you. Ms. Finucane. Ms. Finucane. Well, I think we are all a little bit new to this insomuch as he made these announcements yesterday. There was not a preamble to it. I think I mentioned earlier in my opening remarks that we are ourselves back into the secondary markets, purchasing mortgage-backed securities. We see the problem that he has outlined, particularly with credit cards, the securitization of credit cards and moving that debt. So the issue is clear. I think we would like to understand better specifically what he means. So I think you are hearing from all of us that conceptually it is interesting. We have no sense of what the details are. Senator Crapo. Thank you. " CHRG-111shrg50815--120 M. AUSUBEL Q.1. Access to Credit: A potential outcome of the new rules could be that consumers with less than a 620 FICO score could be denied access to a credit card. Such an exclusion could affect 45.5 million individuals or over 20 percent of the U.S. population. Without access to traditional credit, where do you believe that individuals would turn to finance their consumer needs? A.1. There is no reason to expect that the new rules will result in the wholesale denial of access to credit cards for any group of consumers that currently has access to credit cards. As such, individuals who currently have access to credit cards are likely to continue to rely primarily on credit cards for their consumer finance needs. Q.2. Risk-Based Pricing: Banks need to make judgments about the credit-worthiness of consumers and then price the risk accordingly. Credit cards differ from closed-end consumer transactions, such as mortgages or car loans, because the relationship is ongoing. I am concerned by the Federal Reserve's new rules on risk-based repricing for a couple of reasons. First, without the ability to price for risks, banks will be forced to treat everyone with equally stringent terms, even though many of these individuals perform quite differently over time. Second, without a mechanism to reprice according to risk as a consumer's risk profile changes, many lenders will simply refuse to extend credit to a large portion of the population. Do you believe that consumers will have access to less credit and fewer choices because of the Fed's new rule? If so, is this a desirable outcome? A.2. There is no reason to expect that consumers will have significantly less access to credit or fewer choices because of the Fed's new rule. The principal effect of the new rule will be to limit penalty pricing of credit card consumers, not to limit access to credit or consumer choices. Q.3. Safety and Soundness and Consumer Protection: I believe firmly that safety and soundness and consumer protection go hand-in-hand. One needs only to look at the disaster in our mortgage markets, for clear evidence of what happens when regulators and lenders divorce these two concepts. A prudent loan is one where the financial institution fully believes that the consumer has a reasonable ability to repay. Do you agree that prudential regulation and consumer protection should both be rigorously pursued together by regulators? A.3. It should be observed that consumer protection, as furthered by the Dodd bill, will help to contribute to the prudency of loans. Consumers will better understand whether they will be able to repay loans, and they will be more likely to avoid loans that they understand they do not have the reasonable ability to repay. Lenders will be unable to rely on penalty interest rates following delinquency, so they will be more likely to avoid making loans that are destined to go delinquent. It is difficult to state an opinion on prudential regulation more generally, without being provided some specificity about the form of prudential regulation being proposed. Q.4. Subsidization of High-Risk Customers: I have been receiving letters and calls from constituents of mine who have seen the interest rates on their credit cards rise sharply in recent weeks. Many of these people have not missed payments. Mr. Clayton, in your testimony you note that credit card lenders have increased interest rates across the board and lowered credit lines for many consumers, including low-risk customers who have never missed a payment. Why are banks raising interest rates and limiting credit apparently so arbitrarily? Does this result in low-risk customers subsidizing people who are high-risk due to a track record of high-risk behavior? A.4. If it is the case that banks are raising interest rates and limiting credit arbitrarily, this is probably due primarily to the financial crisis and the economic downturn. Under normal circumstances, credit card lending is highly profitable and there is little reason for banks to reduce credit lines. Banks do raise interest rates, but usually not across the board, as this would result in the loss of some profitable customers. There is no reason to expect that the new rules will lead to cross-subsidization of any particular group of customers. Q.5. Effects on Low-income Consumers: I want to put forward a scenario for the witnesses. Suppose a credit card customer has a low income and a low credit limit, but a strong credit history. They use their credit card for unexpected expenses and pay it off as soon as possible, never incurring late fees. With the new regulations approved by the Federal Reserve, banks will be restricted in their use of risk-based pricing. This means our cardholder could see his or her interest rates and fees increased to pay for the actions of other card holders, many of whom have higher incomes. Do any of the witnesses have concerns that moving away from risk-based pricing could result in the subsidization of credit to wealthy yet riskier borrowers, by poorer but lower-risk borrowers? A.5. No. There is no reason to expect that the new rules will lead to cross-subsidization of any particular group of customers. The principal effect of the new rules will be to limit increases in credit card interest rates following late payments. As documented in my written testimony, the typical increases in interest rates bear no reasonable relation to default risk. The penalties imposed on consumers are typically at least double or triple the enhanced credit losses attributable to these consumers. The terminology of ``risk-based pricing'' for the regulated practices is a misnomer; it is more accurately viewed as ``penalty pricing.'' Under the new rules, banks will still be able to charge higher interest rates (upfront) to riskier customers. That is, true risk-based pricing will still be possible within the rules. ------ RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM TRAVIS CHRG-111hhrg52261--136 Mr. Hampel," Well, Madam Chair, speaking for credit unions, my understanding of systemic risk is such that if even the largest 10 credit unions were all to get into extreme difficulty at same time, it would not spread to the rest of the financial system. So I don't think that credit unions could ever be the source of systemic risk, just by the nature of their size. However, credit unions, because they are connected and users of the rest of the financial system, can be victims of the systemic risk of other institutions; and that is why we are interested in the issue. " FinancialCrisisInquiry--659 GORDON: We do work on credit—credit card issues. FOMC20080625meeting--212 210,MR. LACKER.," So it's essentially the risk that, after the fact, marks are questioned, and they ask, ""You guys were in there--why didn't you . . .?"" I understand that. Thanks. The third question is for Pat. You talked about the repo market. My understanding is that some supervisory work under the LFI (large financial institution) umbrella is aimed at conditions in the repo market and mitigating some risk there. You mentioned that it was obviously an important factor in Bear. To what extent do you think paying interest on demand deposits would obviate the need for the huge volume of transactions in the repo market and the extent to which that legislative prohibition could have contributed to the market structures and fragility that gave rise to what happened in Bear. " FOMC20081029meeting--187 185,MR. STOCKTON.," What we wanted to convey in the alternative scenarios that we showed this time--and we reduced the number because we thought the possible little risks that you might be facing were being swamped by some really big ones--was our sense that the likelihood function is pretty flat around the baseline and the two alternative scenarios that we show here in exhibit 5. I share your discomfort. As I was telling President Evans at lunch today, I feel a bit as though the forecast is going to depend a lot on when the clock stopped, given how much volatility there has been in the stock market and in corporate spreads. When the clock stopped, we had close to a 25 percent weaker level on the stock market, 200 basis points higher on the Baa spread, and a 7 percent higher dollar. There were a whole lot of negative forces operating on this forecast. Indeed, both the conventional wealth effect and cost-of-capital channels account for about one-third of the downward revision we made. The special nonconventional credit channel effects account for a third, and a third of the downward revision really is a combination of the stronger dollar and the weaker foreign outlook. The part that I feel most comfortable with in this forecast is that there has been a very significant negative shock to the economy and that it is difficult to imagine that activity will not be affected importantly by that. The part that I feel most uncertain about--and, as you point out, is relevant to the policy decisions that you are going to make over the next several meetings--is that I have no idea about the timing or the manner in which this will fade away. So we have it fading away gradually over the next two years. I think that a more rapid recovery is certainly a possibility. As you noted, even that scenario doesn't go back to where we were in September. One, the incoming data suggest that the underlying economy is starting out at a weaker place, and even if conditions were to improve very rapidly over the next quarter or two, you have still sustained a hit that is going to take some time to play out through the system. By the same token, I don't think that you can discount the more extended and deeper financial fallout here. We have certainly been surprised over the past year in many ways by just how virulent and persistent this shock has been. Two, looking at the current state of aggregate demand and aggregate activity, I think we are probably still just at the front edge of the credit constraint effects on actual spending. So you could still be faced with some very substantial restraint on spending--and more than we have built into the baseline forecast. So, and as you noted, the difference in the policy prescriptions there--the worse scenario is that the funds rate stays as low as it can stay for several years. The other would be--putting too fine a point on it--that optimal control, even with the more rapid recovery, goes down to 1 percent on the funds rate and then starts recovering to 1� percent. But that is obviously a very different policy picture. I just don't think that, at this point, science is going to allow us to put a lot of probability mass on one of those scenarios versus the other two. " CHRG-109shrg30354--83 Chairman Bernanke," I think what we should do broadly is to diversify our portfolio, to have a wider range of energy sources including ethanol, coal, nuclear, and other possibilities. And I think there are a number of ways Government can help, but in two ways in particular. The Government has, in the past, been effective in helping in basic research. That is research that individual companies do not find it profitable to undertake because they cannot appropriate the returns. I think we also need to try to increase the amount of regulatory certainty. It is certainly appropriate to have regulations that offset environmental and other concerns. That is totally appropriate. But there is so much uncertainty about what the regulations will be when the time comes to apply them that many projects simply do not get undertaken. So if we can provide clearer mechanisms by which those who wish to build new energy sources can understand what is expected of them, I think we will see, given the very high prices we are seeing for oil, we will see, over the next few years, a lot of alternative energy sources coming forward. Senator Carper. Thank you. I would just share with you and our friends, I think it was 106 years ago this year that the very first diesel engine was introduced. I believe it was at an exhibition in Paris, France. It was powered by peanut oil. We now just opened up last month, in the central part of my State, not too far from where Senator Sarbanes is from, Dover, a biodiesel refinery which is run entirely on soybean oil, which we have a lot of on the Delmarva Peninsula, as Senator Sarbanes knows. The other thing, we just got a new air conditioner at our house, and we also got a new air-conditioning standard, a new SEAR standard for air-conditioning efficiencies this year. The new standard is SEAR-13, as opposed to SEAR-8. And we had a battle over whether we were going to go to SEAR-10 or SEAR-13. We ended up at SEAR-13. What that means, just the difference between a SEAR-10 and a SEAR-13 with respect to energy consumption, it means roughly 50 or so power plants we will not have to build over the next 15 or 20 years, simply by having SEAR-13 standards for new air conditioners, as opposed to SEAR-10. Thank you. " FinancialCrisisReport--191 In 1999, WaMu’s parent holding company, Washington Mutual Inc., purchased Long Beach Mortgage Company (Long Beach). Long Beach’s business model was to issue subprime loans initiated by third party mortgage lenders and brokers and then sell or package those loans into mortgage backed securities for sale to Wall Street firms. Beginning in 1999, Washington Mutual Bank worked closely with Long Beach to sell or securitize its subprime loans and exercised oversight over its lending and securitization operations. Because Long Beach was a subsidiary of Washington Mutual Inc., the holding company, however, and not a subsidiary of Washington Mutual Bank, OTS did not have direct regulatory authority over the company, but could review its operations to the extent they affected the holding company or the bank itself. OTS was aware of ongoing problems with Long Beach’s management, lending and risk standards, and issuance of poor quality loans and mortgage backed securities. OTS reported, for example, that Long Beach’s “early operations as a subsidiary of [Washington Mutual Inc.] were characterized by a number of weaknesses” including “loan servicing weaknesses, documentation exceptions, high delinquencies, and concerns regarding compliance with securitization-related representations and warranties.” 717 OTS also reported that, in 2003, “adverse internal reviews of [Long Beach] operations led to a decision to temporarily cease securitization activity” until a “special review” by the WaMu legal department ensured that file documentation “adequately supported securitization representations and warranties” made by Long Beach. 718 OTS was aware of an examination report issued by a state regulator and the FDIC after a review of 2003 Long Beach loans, which provides a sense of the extent of problems with those loans at the time: “An internal residential quality assurance (RQA) report for [Long Beach]’s first quarter 2003 … concluded that 40% (109 of 271) of loans reviewed were considered unacceptable due to one or more critical errors. This raised concerns over [Long Beach]’s ability to meet the representations and warranty’s made to facilitate sales of loan securitizations, and management halted securitization activity. A separate credit review report … disclosed that [Long Beach]’s credit management and portfolio oversight practices were unsatisfactory. … Approximately 4,000 of the 13,000 loans in the warehouse had been reviewed … of these, approximately 950 were deemed saleable, 800 were deemed unsaleable, and the remainder contained deficiencies requiring remediation prior to sale. … [O]f 4,500 securitized loans eligible for foreclosure, 10% could not be foreclosed due to documentation issues.” 719 Despite these severe underwriting and operational problems, Long Beach resumed securitization of its subprime loans in 2004. In April 2005, OTS examiners circulated an internal email commenting on the poor quality of Long Beach loans and mortgage backed securities compared to its peers: 717 12/21/2005 OTS internal memorandum by OTS examiners to OTS Deputy Regional Director, OTSWMS06-007 0001010, Hearing Exhibit 4/16-31. 718 Id. 719 1/13/2004 FDIC-Washington State joint visitation report, FDIC-EM_00102515-20, Hearing Exhibit 4/13-8b. OTS held a copy of this report in its files, OTSWME04-0000029592. “Performance data for 2003 and 2004 vintages appear to approximate industry average while issues prior to 2003 have horrible performance. . . . [Long Beach] finished in the top 12 worst annualized [Net Credit Losses] in 1997 and 1999 thru 2003. [Long Beach nailed down the number 1 spot as top loser with an [Net Credit Loss] of 14.1% in 2000 and placed 3 rd in 2001 with 10.5%. … For ARM [adjustable rate mortgage] losses, [Long FOMC20081216meeting--88 86,MS. PIANALTO.," Thank you, Mr. Chairman. I also want to start by thanking the staff for the excellent background materials they provided. While I certainly wish we were not in this circumstance, I do think that this is a critical conversation for us to be having at this meeting, and the background materials were extremely helpful. I am going to proceed directly to the questions that Brian provided as I believe they cover the major issues well. I have some general answers to the questions, but I think that we are going to be learning a lot in the process of implementing policies into ever more uncharted waters. On the question of whether the Committee should quickly move the target fed funds rate toward the zero bound or get there more gradually, I strongly support moving quickly. I agree with the memos that the Japanese experience points to the value of moving aggressively. Also, we have already moved beyond the targeted fed funds rate as many have commented, and so we are merely confirming a reality. On the questions pertaining to the costs to financial markets or institutions and the limits to our rate reduction, I think the notes covered very well the costs to some money market funds. Bankers in my District have also expressed concerns about additional margin squeezing that they will face with a lower fed funds rate. So, yes, there are significant costs to financial markets and institutions. However, I believe that the current environment and our need to allow the fed funds rate to trade close to zero trumps these costs, and in my view a 25 basis point fed funds rate is an appropriate minimum. Regarding the question about the communication strategy, I think another lesson that we have learned from the Japanese experience is the role of effective communication and the role of anchoring inflation expectations. So I do see the benefit in communicating that the Federal Reserve intends to hold the target fed funds rate at a very low level until specified conditions are obtained, and that the Committee sees a sizable risk that inflation in the coming quarters could be appreciably lower than is consistent with price stability. I also see that there may be some value to communicating that our policies might result in a temporarily higher inflation rate in the future, both to indicate this possibility and to signal a willingness to make sure that the risk of deflation dissipates before we alter our course. Although we have not adopted a formal inflation target, I do believe that the release of our longer-term projections as suggested by the Subcommittee on Communications will be helpful in managing inflation expectations. Moving to questions 4 and 5 regarding nonstandard policy tools, my own preference is for a mixed strategy--that is, some direct Treasury and agency purchases and some expansion of our private asset purchases using the TALF. I support your view, Mr. Chairman, that we should keep our focus on expanding the asset side of our balance sheet. I think we should consider increasing the purchase of agency debt and mortgage-backed securities beyond the levels that we have already announced. I also see advantages in initiating large-scale purchases of longer-term Treasury securities. These actions should help to lower interest rates across a broad spectrum of longer-term assets. As we have talked about, direct purchases also fit more naturally into the FOMC's governance structure, whereas the TALF-like approach is more awkward to fit into the FOMC's purview. As some have commented, direct purchases might expose our System Open Market Account to some capital losses, but that seems an acceptable risk for monetary policy in such a challenging environment. I do think that the focus of our FOMC meetings next year should be on evaluating and adjusting the composition and size of our purchase of securities in response to changing economic conditions so that the directive need not build in explicit conditioning on market and economic circumstances. Further expansion of our credit backstop facilities under section 13(3) is also likely to be beneficial in current circumstances. I think the CPFF has been a helpful addition to our facilities, and I am hopeful that the TALF will be equally effective. So, in summary, I favor applying all of these approaches and remaining flexible. I also believe that a clear starting point on how the Committee would formulate its directive would be to direct the Desk to purchase specific quantities of assets. As a formal matter, we might need to include ""up to"" in our directive language, but we should anticipate that the Desk would be successful in meeting that objective. I think that the uncertainty surrounding the effects of our actions makes longer-term interest rates or spreads too unreliable to be communicated as targets. Finally, on the question of effectively communicating nonstandard policy tools, I liked the language in some of the Bluebook alternatives for our policy options. However, because of the historic nature of implementing nonstandard policy tools, I think that a good communication plan should also include a formal press conference or a speech in which, Mr. Chairman, you announce the changes. That would serve to emphasize the change in our procedure and eliminate some of the uncertainties about the role of the fed funds rate target. Thank you, Mr. Chairman. " CHRG-111hhrg52261--91 Mr. Hirschmann," Access to credit is a significantly enhanced problem in this crisis. What our study finds is that even before the crisis, half of the smallest firms had access-to-credit problems. It is clearly magnified. I don't know whether you point--obviously, you don't want banks to make loans that are being given to inadequate--people that don't have adequate credit. On the other hand, you want to make sure that the small businesses have credit. That is why this secondary credit market, the ability of small firms to rely on their personal credit, especially when they are starting a business, is vital to start-ups and vital to creating new jobs in this country. " CHRG-111hhrg52261--158 Mr. Hampel," This year, credit unions will pay an insurance premium of 15 basis points of their insured shares, which is higher than what it normally is for credit unions, but it is because of losses, collateral damage credit unions have experienced. We typically fund our system by credit unions makeing deposits into the fund, and it is the earnings from those deposits that the insurance fund uses to operate. Probably, for the next several years, credit unions will be paying premiums of about 15 basis points. It is probably less than what FDIC-insured institutions will pay, but it is significant compared to what credit unions have historically paid. " CHRG-111shrg57319--195 Mr. Melby," Yes. Senator Coburn. All right. Thank you. I have no other questions, Mr. Chairman. Senator Levin. Mr. Melby, take a look, if you would, at Exhibit 34.\1\ This is a September 8, 2008, report from the Corporate Credit Review group. I think this review is not part of your audit team, but a copy of the report was sent to your staff, Debbie Dahl-Amundson. Is that correct?--------------------------------------------------------------------------- \1\ See Exhibit No. 34, which appears in the Appendix on page 564.--------------------------------------------------------------------------- " CHRG-111hhrg48873--439 Secretary Geithner," Well, you are right to express that concern, and we are going to have to make sure that we design these conditions carefully to help mitigate that risk. And we are going to have to come to a better balance with the Congress as again we try to figure out how to respond to the reasonably perfectly understandable public outrage. We are not using public assistance to reward failure, but still get our system working again, and that is going to require people taking risk, be willing to take risk so the government doesn't have to assume all the losses in solving this financial crisis. And we are going have to get to a better place, both the Congress and the Executive Branch, on this very complicated question. " FOMC20070321meeting--179 177,MR. KOHN.," I think there was back in 2001, after we cut rates, but I’m not sure. Overall my concern about cutting things off after “quarters” or “gains in income” is that such a statement would be kind of weak. We say that indicators have been mixed and adjustment in the housing sector is ongoing, but there’s an act of faith here. Somehow not giving some rationale for the moderate growth in income ahead weakens the statement. The income phrase always struck me as endogenous: “We think that growth is going to be moderate and that income will go up with growth.” But I can see the worries about the mention of financial conditions. Most people around the table mentioned that concern." CHRG-110hhrg46594--195 Mr. Wagoner," Sure. Thank you. I want to be candid to your comment about, can we tell you with absolute certainty that this is the total amount, that this is the exact amount needed. Could it be more? Could it be less? The honest response is, I don't think anybody knows that today because we have to assume when the U.S. economy is going to stabilize, when automotive sales will stop going down and when they will stabilize and hopefully begin to go up. We have to assume that eventually the credit markets and capital markets begin to function, which they don't today. We are here very simply because our revenue has been devastated because people can't afford to buy cars or can't get credit and the traditional sources of credit that we have relied upon are simply not available. " FOMC20080130meeting--335 333,VICE CHAIRMAN GEITHNER.," Thank you. I agree with President Poole and President Yellen about the need to focus on compensation structures and incentives, but just two observations. One is that, if you look at compensation practices among the guys who actually look as though they did pretty well against those who didn't do so well--I'm not talking about in a mortgage-origination sense but in the major global financial institutions--the structure of compensation doesn't vary that much. What varies a lot is how well people control for the inherent problems in the basic compensation structures. Remember Raghu's presentation was mostly about hedge fund compensation, and I think he is mostly wrong when you think about that and the incentive structure. The difference really is how you design your limits to make sure that your traders' incentives are more aligned with the incentives of the firm as a whole. The biggest errors and differences are in the design of the process of the checks and balances to compensate for the inherent problems in the compensation structure. That's important to know because a lot of these things, if you look at the formal attributes of the risk-management governance structure across these firms, don't look that different. What distinguishes how well the guys did is much more subtle around culture, independence, and the quality of judgment exercised at the senior level, and this is important because, when you think about what you can do through supervision and regulation, to affect that stuff is hard. I have a question for Pat. Pat, not to overdo this, but where do you put in your diagnosis of contributing factors the constellation of financial conditions that prevailed during the boom and what those did to housing prices? You know, there's a tendency for everybody to look at regulation and supervision and the incentives that they have created or failed to mitigate, but there is a reasonable view of the world that you wouldn't have had the pattern of underwriting standards of mortgages without the trajectory of house prices that occurred. Sure, maybe what happened in the late stage of the mortgage-origination process contributed to the upside, but if you look at a chart, the rate of house-price appreciation started to decelerate about the time you had the worst erosion in underwriting practices. Anyway, my basic question is, Where do you put the constellation of financial conditions, not so much just what the Fed was doing but what was happening globally that affected long rates, expectations of future rates, et cetera? " fcic_final_report_full--163 In late , Moody’s would throw out its key CDO assumptions and replace them with an asset correlation assumption two to three times higher than used before the crisis.  In retrospect, it is clear that the agencies’ CDO models made two key mistakes. First, they assumed that securitizers could create safer financial products by diversi- fying among many mortgage-backed securities, when in fact these securities weren’t that different to begin with. “There were a lot of things [the credit rating agencies] did wrong,” Federal Reserve Chairman Ben Bernanke told the FCIC. “They did not take into account the appropriate correlation between [and] across the categories of mortgages.”  Second, the agencies based their CDO ratings on ratings they themselves had as- signed on the underlying collateral. “The danger with CDOs is when they are based on structured finance ratings,” Ann Rutledge, a structured finance expert, told the FCIC. “Ratings are not predictive of future defaults; they only describe a ratings man- agement process, and a mean and static expectation of security loss.”  Of course, rating CDOs was a profitable business for the rating agencies. Includ- ing all types of CDOs—not just those that were mortgage-related—Moody’s rated  deals in ,  in ,  in , and  in ; the value of those deals rose from  billion in  to  billion in ,  billion in , and  billion in .  The reported revenues of Moody’s Investors Service from struc- tured products—which included mortgage-backed securities and CDOs—grew from  million in , or  of Moody’s Corporation’s revenues, to  million in  or  of overall corporate revenue. The rating of asset-backed CDOs alone contributed more than  of the revenue from structured finance.  The boom years of structured finance coincided with a company-wide surge in revenue and profits. From  to , the corporation’s revenues surged from  million to  billion and its profit margin climbed from  to . Yet the increase in the CDO group’s workload and revenue was not paralleled by a staffing increase. “We were under-resourced, you know, we were always playing catch-up,” Witt said.  Moody’s “penny-pinching” and “stingy” management was re- luctant to pay up for experienced employees. “The problem of recruiting and retain- ing good staff was insoluble. Investment banks often hired away our best people. As far as I can remember, we were never allocated funds to make counter offers,” Witt said. “We had almost no ability to do meaningful research.”  Eric Kolchinsky, a for- mer team managing director at Moody’s, told the FCIC that from  to , the increase in the number of deals rated was “huge . . . but our personnel did not go up accordingly.” By , Kolchinsky recalled, “My role as a team leader was crisis man- agement. Each deal was a crisis.”  When personnel worked to create a new method- ology, Witt said, “We had to kind of do it in our spare time.”  The agencies worked closely with CDO underwriters and managers as each new CDO was devised. And the rating agencies now relied for a substantial amount of their revenues on a small number of players. Citigroup and Merrill alone accounted for more than  billion of CDO deals between  and .  The ratings agencies’ correlation assumptions had a direct and critical impact on how CDOs were structured: assumptions of a lower correlation made possible larger easy-to-sell triple-A tranches and smaller harder-to-sell BBB tranches. Thus, as is discussed later, underwriters crafted the structure to earn more favorable ratings from the agencies—for example, by increasing the size of the senior tranches. More- over, because issuers could choose which rating agencies to do business with, and be- cause the agencies depended on the issuers for their revenues, rating agencies felt pressured to give favorable ratings so that they might remain competitive. The pressure on rating agency employees was also intense as a result of the high turnover—a revolving door that often left raters dealing with their old colleagues, this time as clients. In her interview with FCIC staff, Yuri Yoshizawa, a Moody’s team managing director for U.S. derivatives in , was presented with an organization chart from July . She identified  out of  analysts—about  of the staff— who had left Moody’s to work for investment or commercial banks.  FOMC20081216meeting--248 246,MR. MADIGAN.," I do have that guideline here, and you are correct, President Lacker. The first paragraph of the guideline says that System open market operations in agency issues are an integral part of open market operations, designed to influence bank reserves, money market conditions, and monetary aggregates. The second paragraph says that open market operations in those issues are not designed to support individual sectors of the market or to channel funds into issues of particular agencies. As you remembered, in my briefing yesterday I did raise the question as to Committee members' views of the allocation of funds to particular firms or sectors. It is possible that the Committee may want to modify, suspend, or repeal this guideline at some point. " CHRG-111shrg55739--144 PREPARED STATEMENT OF MICHAEL S. BARR Assistant Secretary for Financial Institutions, Department of the Treasury August 5, 2009 Chairman Dodd, Ranking Member Shelby, and Members of the Committee, thank you for the opportunity to testify before you today about the Administration's plan for financial regulatory reform. On June 17, President Obama unveiled a sweeping set of regulatory reforms to lay the foundation for a safer, more stable financial system; one that properly delivers the benefits of market-driven financial innovation while safeguarding against the dangers of market-driven excess. In the weeks since the release of those proposals, the Administration has worked with Congress in testimony and briefings with your staff to explain and refine our legislation. Today, I want to first speak in broad terms about the forces that led us into the current crisis and the key objectives of our reform proposal. I will then turn to discuss the role that third party credit ratings and rating agencies played in creating a system where risks built up without being accounted for or properly understood. And how these ratings contributed to a system that proved far too fragile in the face of changes in the economic outlook and uncertainty in financial markets. This Committee provided strong leadership to enact the first registration and regulation of rating agencies in 2006, and the proposals that I will discuss today build on that foundation.Where Our Economy Stands Today President Obama inherited an economic and financial crisis more serious than any President since Franklin Roosevelt. Over the last 7 months, the President has responded forcefully with a historic economic stimulus package, with a multiprong effort to stabilize our financial and housing sectors, and, in June, with a sweeping set of reforms to make the financial system more stable, more resilient, and safer for consumers and investors. We cannot be complacent; the history of major financial crises includes many false dawns and periods of optimism even in the midst of the worst downturns. But I think you will agree that the sense of free fall that surrounded the economic statistics earlier this spring has now abated. Even amidst much continued uncertainty, we must reflect on the extraordinary path our economy and financial system have taken over the past 2 years, and take this opportunity to restore confidence in the system through fundamental reform. We cannot afford to wait.Forces Leading to the Crisis At many turns in our history, we have seen a pattern of tremendous growth supported by financial innovation. As we consider financial reform, we need to be mindful of the fact that those markets with the most innovation and the fastest growth seemed to be at the center of the current crisis. But in this cycle, as in many cycles past, growth often hid key underlying risks, and innovation often outpaced the capacity of risk managers, boards of directors, regulators, rating agencies, and the market as a whole to understand and respond. Securitization helped banks move credit risk off of their books and supply more capital to housing markets. It also widened the gaps between borrowers, lenders, and investors--as lenders lowered underwriting standards since the securitized loans would be sold to others in the market, while market demand for securitized assets lowered the incentives for due diligence. Rapidly expanding markets for hedging and risk protection allowed for better management of corporate balance sheets, enabling businesses to focus on their core missions; credit protection allowed financial institutions to provide more capital to business and families that needed it, but a lack of transparency hid the movement of exposures. When the downturn suddenly exposed liquidity vulnerabilities and large unmanaged counterparty risks, the uncertainty disrupted even the most deeply liquid and highly collateralized markets at the center of our financial system. It is useful to think about our response to this crisis in terms of cycles of innovation. New products develop slowly while market participants are unsure of their value or their risks. As they grow, however, the excitement and enthusiasm can overwhelm normal risk management systems. Participants assume too soon that they really ``know how they work,'' and these new products, applied widely without thought to new contexts--and often carrying more risk--flood the market. The cycle turns, as this one did, with a vengeance, when that lack of understanding and that excess is exposed. But past experience shows that innovation survives and thrives again after reform of the regulatory infrastructure renews investor confidence. Innovation creates products that serve the needs of consumers, and growth brings new players into the system. But innovation demands a system of regulation that protects our financial system from catastrophic failure, protects consumers and investors from widespread harm and ensures that they have the information they need to make appropriate choices. Rather than focus on the old, ``more regulation'' versus ``less regulation'' debate, the questions we have asked are: why have certain types of innovation contributed in certain contexts to outsized risks? Why was our system ill-equipped to monitor, mitigate and respond to those risks? Our system failed to provide transparency in key markets, especially fast developing ones. Rapid growth hid misaligned incentives that people didn't recognize. Throughout our system we had inadequate capital and liquidity buffers--as both market participants and regulators failed to account for new risks appropriately. The apparent short-term rewards in new products and rapidly growing markets created incentives for risk-taking that overwhelmed private sector gatekeepers, and swamped those parts of the system that were supposed to mitigate risk. And households took on risks that they did not fully understand and could ill-afford. Our proposals identify sweeping reforms to the regulation of our financial system, to address an underlying crisis of confidence--for consumers and for market participants. We must create a financial system that is safer and fairer; more stable and more resilient.Protecting Consumers We need strong and consistent regulation and supervision of consumer financial services and investment markets to restore consumer confidence. In early July, we delivered the first major portion of our legislative proposals to the Congress, proposing to create a Consumer Financial Protection Agency (CFPA). We all aspire to the same objectives for consumer protection regulation: independence, accountability, effectiveness, and balance--a system that promotes financial inclusion and preserves choice. The question is how to achieve that. A successful regulatory structure for consumer protection requires mission focus, marketwide coverage, and consolidated authority. Today's system has none of these qualities. It fragments jurisdiction and authority for consumer protection over many Federal regulators, which have higher priorities than protecting consumers. Banks can choose the least restrictive supervisor among several different banking agencies. Nonbank providers avoid Federal supervision altogether; no Federal consumer compliance examiner ever lands at their doorsteps. Fragmentation of rule writing, supervision, and enforcement leads to finger-pointing in place of action and makes actions taken less effective. The President's proposal for one agency for one marketplace with one mission--protecting consumers--will resolve these problems. The Consumer Financial Protection Agency will create a level playing field for all providers, regardless of their charter or corporate form. It will ensure high and uniform standards across the market. It will support financial literacy for all Americans. It will prohibit misleading sales pitches and hidden traps, but there will be profits made on a level playing field where banks and nonbanks can compete on the basis of price and quality. If we create one Federal regulator with consolidated authority, then we will be able to leave behind regulatory arbitrage and interagency finger pointing. And we will be assured of accountability. Our proposal ensures, not limits, consumer choice; preserves, not stifles, innovation; strengthens, not weakens, depository institutions; reduces, not increases, regulatory costs; empowers, not undermines, consumers; and increases, not reduces, national regulatory uniformity.Systemic Risk Much of the discussion of reform over the past 2 years--both in our proposals and among other commentators--has focused on both the nature of and proper response to systemic risk. To address these risks, our proposals focus on three major tasks: (1) providing an effective system for monitoring risks as they arise and coordinating a response; (2) creating a single point of accountability for tougher and more consistent supervision of the largest and most interconnected institutions; and (3) tailoring the system of regulation to cover the full range of risks and actors in the financial system, so that risks can no longer build up completely outside of supervision and monitoring. Many have asked whether we need a ``systemic risk regulator'' or a ``super regulator'' that can look out for new risks and immediately take action to address them or order other regulators to do so. That is not what we are proposing. We cannot have a system that depends on the foresight of a single institution or a single person to identify and prevent risks. That's why we have proposed that the critical role of monitoring for emerging risks and coordinating policy responses be vested in a Financial Services Oversight Council. At the same time, a council of independent regulators with divergent missions will not have operational coherence and cannot be held accountable for supervision of individual financial firms. That's why we propose an evolution in the Federal Reserve's power to provide consolidated supervision and regulation of any financial firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed. The financial crisis has demonstrated the crucial importance of having a consolidated supervisor and regulator for all ``Tier 1 Financial Holding Companies,'' with the regulator having the authority and responsibility to regulate these firms not just to protect their individual safety and soundness but to protect the entire financial system. This crisis has also clearly demonstrated that risks to the system can emerge from all corners of the financial markets and from any of our financial institutions. Our approach is to bring these institutions and markets into a comprehensive system of regulation, where risks are disclosed and monitored by regulators as necessary. Secretary Geithner has testified about the need to bring all over-the-counter derivatives markets into a comprehensive regulatory framework. In the next few days we will deliver legislative text to this Committee that would accomplish that goal. We have delivered proposed legislation that would strengthen the regulation of securitization markets, expand regulatory authority for clearing, payment, and settlement systems, and require registration of hedge funds.Basic Reform of Capital, Supervision, and Resolution Authority As Secretary Geithner has said, the three most important things to lower risk in the financial system are ``capital, capital, capital.'' We need to make our financial system safer and more resilient. We cannot rely on perfect foresight--whether of regulators or firms. Higher capital charges can insulate the system from the build-up of risk without limiting activities in the markets. That's why we have launched a review of the capital regime and have proposed raising capital and liquidity standards across the board, including higher standards for financial holding companies, and even higher standards for Tier 1 Financial Holding Companies--to account for the additional risk that the largest and most interconnected firms could pose to our system. Making the system safe for innovation means financial firms should raise the amount of capital that they hold as a buffer against potential future losses. It also means creating a more uniform system of regulation so that risks cannot build up due to inadequate regulatory oversight. To strengthen banking regulation, we propose removing the central source of arbitrage among depository institutions. Our proposed National Bank Supervisor would consolidate the Office of Thrift Supervision and the Office of the Comptroller of the Currency. We will also close loopholes in the Bank Holding Company Act that allow firms to own insured depository institutions yet escape consolidated supervision and regulation. Financial activity involves risk, and the fact is that we will not be able to identify all risks or prevent all future crises. We learned through painful experience that during times of great stress, the disorderly failure of a large, interconnected institution can threaten the stability of the entire financial system. While we have a tested and effective system for resolving failing banks, there is still no effective legal mechanism to resolve a nonbank financial institution or bank holding company. We have proposed to fill this gap in our legal framework with a mechanism modeled on our existing system under the We have proposed to fill this gap in our legal framework with a mechanism modeled on our existing system under the Federal Deposit Insurance Corporation (FDIC). Finally, both our financial system and this crisis have been global in scope. Our solutions have been and must continue to be global. International reforms must support our efforts at home, including strengthening the capital framework; improving oversight of global financial markets; coordinating supervision of internationally active firms; and enhancing crisis management tools. We will not wait for the international community to act before we reform at home, but nor will we be satisfied with an international race to the bottom on regulatory standards.Credit Ratings and Fragility It's worthwhile to begin our discussion on credit ratings with a basic explanation of the role that they play in our economy. Rating agencies solve a basic market failure. In a market with borrowers and lenders, borrowers know more about their own financial prospects than lenders do. Especially in the capital markets, where a lender is likely purchasing just a small portion of the borrower's debt in the form of a bond or asset-backed security--it can be inefficient, difficult and costly for a lender to get all the information they need to evaluate the credit worthiness of the borrower. And therefore lenders will not lend as much as they could, especially to lesser known borrowers such as smaller municipalities; or lenders will offer higher rates to offset the uncertainty. Credit rating agencies provide a third party rating based on access to more information about the borrower than a lender may be able to access, and on accumulated experience in evaluating credit. By issuing a rating of the creditworthiness of a borrower, they can validate due diligence performed by lenders and enhance the ability of borrowers to raise funds. Further, the fact the credit rating agencies rate a wide variety of credit instruments and companies allowed debt investors to have the benefit of a consistent, relative assessment of credit risk across different potential investments. This role is critical to municipalities and companies to access the capital markets, and rating agencies have facilitated the growth of securitization markets, increasing the availability of mortgages, auto loans, and small business loans. Credit ratings also played an enabling role in the buildup of risk and contributed to the deep fragility that was exposed in the past 2 years. As I discussed before, the current crisis had many causes but a major theme in each was that risk--complex and often misunderstood--was allowed to build up in ways that the supervisors and regulators were unable to monitor, prevent or respond to effectively. Earnings from rapid growth driven by innovation overwhelmed the will or ability to maintain robust internal risk management systems. As the Members of this Committee know, the highest rating given by rating agencies is ``triple-A.'' An easy way to understand the importance of a triple-A rating for a borrower or an investor is that this label is the same one given to the U.S. Government. It means that the rating agency estimates that the probability of default--or the debt investor losing money--in the following year is extremely remote. The ``triple-A'' designation was therefore highly valued, but perversely, rather than preserve this designation for the few, the amount of securities and borrowers that were granted this designation became much more prevalent as borrowers and issuers were able to convince the rating agencies that innovation in the structured credit market allowed for the creation of nearly riskless credit investments. Market practices such as ``ratings shopping'' before contracting for a rating, and the creation of consulting relationships may have contributed to conflicts of interest and upward pressure on ratings. Rating agencies have a long track record evaluating the risks of corporate, municipal, and sovereign bonds. These ratings are based on the judgment of rating agencies about the credit worthiness of a borrower and are usually based on confidential information that is not generally available to the market, including an assessment of the borrower's income, ability to meet payments, and their track record for doing so. Evaluating a structured finance product is a fundamentally different type of analysis. Asset-backed securities represent a right to the cash flows from a large bundle of smaller assets. In this way an investor can finance a small portion of hundreds or thousands of loans, rather than directly lending to a single borrower. This structure diversifies the investor's risk with respect to a given borrower's default and averages out the performance of the investment to be equal to a more general class of borrowers. It also allows more investors to participate in the market, since the investor's capital no longer needs to be tied to the origination of a loan. Certain asset-backed securities also relied on a process of ``tranching''--slicing up the distribution of potential losses to further modify the return of the security to meet the needs of different investors. This process relied on quantitative models and therefore could produce any probability of default. Credit ratings lacked transparency with regard to the true risks that a rating measured, the core assumptions that informed the rating and the potential conflicts of interest in the generation of that rating. This was particularly acute for ratings on asset-backed securities, where the concentrated systematic risk of senior tranches and resecuritizations are quite different from the more idiosyncratic risks of corporate bonds. As we discovered in the past 2 years, the risks of asset-backed securities are much more highly correlated to general economic performance than other types of bonds. The more complicated products are also sensitive to the assumptions in the quantitative models used to create these products. Investors, as described earlier, relied on the rating agencies' ability to assess risk on a similar scale across instruments. They therefore saw highly rated instruments and borrowers as generally similar even though the investments themselves ranged from basic corporate bonds to highly complex bonds backed by loans or other asset-backed securities. Investors, and even regulatory bodies, rather than using ratings as one of many tools in their credit decisions, began to rely entirely on the ratings and performed little or no due diligence. Further, investors ventured into products they understood less and less because they carried the ``seal of approval'' from the rating agencies. This reliance gave the ratings agencies an extraordinary amount of influence over the fixed income markets and the stability of these markets came to depend, to a large degree, on the robustness of these ratings. Ultimately, this led to a toxic combination of overreliance on a system for rating credit that was not transparent and highly conflicted. Many of the initial ratings made during this period turned out to be overly optimistic. When it became clear that ``triple A'' securities were not as riskless as advertised, it caused a great amount of disruption in the fixed income markets. One of the central examples of these problems is in the market for Collateralized Debt Obligations or ``CDOs.'' These products are created by pooling a group of debt instruments, often mortgage loans, then slicing up the economic value of the cash flows to create tailored combinations of risk and return. The senior tranches would have the first right to payments, while the most junior tranche--often called the ``equity'' tranche--would not be paid until all others had been paid first. These new products were highly complex and difficult for most investors to evaluate on their own. Rating agencies stepped into this gap and provided validation for the sale of these products, because their quantitative models and assumptions often determined that the most senior tranches could be rated triple-A. Without this designation, many pension funds, insurance companies, mutual funds, and banks would never have been willing to invest. Many investors did not realize that the ratings were highly dependent on the economic cycle or that the ratings for many CDOs backed by subprime mortgage bonds assumed that there would never be a nationwide decline in housing prices. This complexity was often ignored as the quarterly issuance of CDOs more than quadrupled from 2004 to mid-2007, reaching $140 billion in the second quarter of 2007. \1\ But following a wave of CDO downgrades in July 2007, the market for CDOs dried up and new issuance collapsed as investors lost confidence in the rating agencies and investors realized they themselves did not understand these investments.--------------------------------------------------------------------------- \1\ SIFMA, CDO Global Issuance Data.--------------------------------------------------------------------------- The reforms proposed by this Administration recognize the market failure that the credit rating agencies help to remedy, but also address the deep problems caused by the manner in which these agencies operated and the overreliance on their judgments.Reform of the Credit Rating System This Committee, under the leadership of Senator Shelby, Senator Dodd, and others, took strong steps to improve regulation of rating agencies in 2006. That legislation succeeded in increasing competition in the industry, in giving much more explicit authority to the SEC to require agencies to manage and disclose conflicts of interest, and helping ensure the existence and compliance with internal controls by the agencies. This authority has already been used by the SEC over the past year to strengthen regulation and enforcement. The Administration strongly supports the actions that the SEC has taken and we will continue to work closely with the SEC to support strong regulation of credit rating agencies. But flaws and conflicts revealed in the current crisis highlight the need for us to go further as more needs to be done. Our legislative proposal directly addresses three primary problems in the role of credit rating agencies: lack of transparency, ratings shopping, and conflicts of interest. It also recognizes the problem of overreliance on credit ratings and calls for additional study on this matter as well as reducing the overreliance on ratings. While there were clear failures in credit rating agency methodologies, our proposals continue to endorse the divide established by this Committee in 2006: The Government should not be in the business of regulating or evaluating the methodologies themselves, or the performance of ratings. To do so would put the Government in the position of validating private sector actors and would likely exacerbate over-reliance on ratings. However, the Government should make sure that rating agencies perform the services that they claim to perform and our proposal authorizes the SEC to audit the rating agencies to make sure that they are complying with their own stated procedures.Lack of Transparency The lack of transparency in credit rating methodologies and risks weakened the ability of investors to perform due diligence, while broad acceptance of ratings as suitable guidelines for investment weakened the incentives to do so. These two trends contributed significantly to the fragility of the financial system. Our proposals address transparency both in the context of rating agency disclosure as well as stronger disclosure requirements in securitization markets more generally. An agency determines a rating with a proprietary risk model that takes account of a large number of factors. While we do not advocate the release of the proprietary models, we do believe that all rating agencies should be required to give investors a clear sense of the variety of risk factors considered and assumptions made. For instance, there are a number of ways to obtain a high rating for an asset-backed security that are not transparent to investors. First, there is the quality of the underlying assets--a bundle of prime mortgage loans will have higher credit worthiness than a bundle of subprime mortgage loans, all things being equal. Second, the rating agency could consider the quality and reliability of the data--fully documented mortgages or consumer credit instruments with a longer performance history (like auto loans) give greater certainty to the rating. Finally, if the security uses tranching or subordination, then giving a greater proportion of the economic value to a certain class of investors will raise the credit rating for that class. In the current system, there is no requirement that these factors be disclosed or compared for investors along with the credit rating. Our proposals would require far more transparency of both qualitative and quantitative information so that investors can carry out their own due diligence more effectively. To facilitate investor analysis, we will require that each rating be supported by a public report containing assessments of data reliability, the probability of default, the estimated severity of loss in the event of default, and the sensitivity of a rating to changes in assumptions. The format of this report will make it easy to compare these data across different securities and institutions. The reports will increase market discipline by providing clearer estimates of the risks posed by different investments. The history of rating agencies assessments in corporate, municipal, and sovereign bonds allowed them to expand their business models to evaluate structured finance products without proving that they had the necessary expertise to evaluate those products. The use of an identical rating system for corporate, sovereign, and structured securities allowed investors to purchase these products under their existing investment standards with respect to ratings. The identical rating systems also allowed regulators to use existing guidelines without the need to consider the different risks posed by these new financial instruments. Our proposals address the disparate risks directly by requiring that rating agencies use ratings symbols that distinguish between structured and unstructured financial products. It is our hope that this will cause supervisors and investors to examine carefully their guidelines to ensure that their investment strategy is appropriate and specific.Ratings Shopping Currently, an issuer may attempt to ``shop'' among rating agencies by soliciting ``preliminary ratings'' from multiple agencies and enlisting the agency that provides the highest preliminary rating. Consistently, this agency also provides a high final rating. A number of commentators have argued that either the existence or threat of such ``ratings shopping'' by issuers played an important role in structured products leading up to the crisis. A recent Harvard University study contains supporting evidence, finding that structured finance issues that were only rated by a single rating agency have been more likely to be downgraded than issues that were rated by two or more agencies. \2\ Our proposal would shed light on this practice by requiring an issuer to disclose all of the preliminary ratings it had received from different credit rating agencies so that investors could see how much the issuer had ``shopped'' and whether the final rating exceeded one or more preliminary ratings. The prospect of such disclosures should also deter ratings shopping in the first place. In addition, the SEC has proposed a beneficial rule that would require agencies to disclose the rating history--of upgrades and downgrades--so that the market can assess the long-term quality of ratings.--------------------------------------------------------------------------- \2\ Benmelech and Dlugosz 2009, ``The Credit Rating Crisis.''--------------------------------------------------------------------------- As an additional check against rating shopping, the Administration supports a proposed SEC rule that would require issuers to provide the same data they provide to one credit rating agency as the basis of a contracted rating to all other credit rating agencies. This will allow other credit rating agencies to provide additional, independent analyses of the issuer to the market. Such ``unsolicited'' ratings, have been ineffective because investors understand that these unsolicited ratings are not based on the same information as the fully contracted ratings, especially for structured products that are often complex and require detailed information to assess. By requiring full disclosure to all rating agencies, this rule would limit any potential benefit from rating shopping and should increase the amount of informed, but independent, research on credit instruments.Conflicts of Interest Our proposals include strong provisions to prevent and manage conflicts of interest, which we identify as a major problem of the current regime. Many of our proposals are aligned with specific provisions proposed by Senator Reed. Our approach is to solve these problems within the current framework rather than prohibiting specific models of rating agency compensation as some have advocated. Both issuer pay and investor pay models exist today and we do not believe it is the place of Government to prescribe allowable business models in the free market. Our proposal will make it simple for investors to understand the conflicts in any rating that they read and allow them to make their own judgment of its relevance to their investment decision. Most directly, we would ban rating agencies from providing consulting services to issuers that they also rate. While these consulting contracts do not currently form a huge proportion of the revenue of the top rating agencies, they are an undeniable source of conflict since they allow for issuers and raters to work closely together and develop economic ties that are not related to the direct rating of securities. For instance, today a rating agency may consult with an issuer on how to structure and evaluate asset-backed securities, and then separately be paid by the issuer to rate the same securities created. This Committee was at the center of a similar effort that banned these types of cross-relationships for audit firms in the passage of the Sarbanes-Oxley Act of 2002, which also required a study of issues with credit rating agencies. Today, we propose that these cross-relationships be simply prohibited. Our proposals also strengthen disclosure and management of conflicts of interest. The legislation will prohibit or require the management and disclosure of conflicts arising from the way a rating agency is paid, its business relationships, its affiliations, or other sources. Each rating will be required to include a disclosure of the fees paid for the particular rating, as well as the total fees paid to the rating agency by the issuer in the previous 2 years. This disclosure will give the market the information it needs to assess potential bias of the rating agency. The legislation also requires agencies to designate a compliance officer, with explicit requirements that this officer report directly to the board or the senior officer, and that the compliance officer have the authority to address any conflicts that arise within the agency. Rating agencies will be required to institute reviews of ratings in cases where their employees go work for issuers, to reduce potential conflicts from a ``revolving door.''Strengthen and Build on SEC Supervision Under the authority created by this Committee in 2006, the SEC has already begun to address many problems with rating agencies. The Treasury supports these actions and has included in our legislative proposal additional authority to strengthen and support SEC regulation of rating agencies. The Commission has allocated resources to establish a branch of examiners dedicated specifically to conducting examination oversight of credit rating agencies, which would conduct routine, special, and cause examinations. Our proposed legislation would strengthen this effort and create a dedicated office for supervision of rating agencies within the Commission. Under the legislation, the SEC will require each rating agency to establish and document its internal controls and processes--and will examine each rating agency for compliance. In line with the principle of consistent regulation and enforcement, our proposal will make registration mandatory for all credit rating agencies--ensuring that these firms cannot evade our efforts to strengthen regulation. In response to the credit market turmoil, in February the SEC took a series of actions with the goal of enhancing the usefulness of rating agencies' disclosures to investors, strengthening the integrity of the ratings process, and more effectively addressing the potential for conflicts of interest inherent in the ratings process for structured finance products. Specifically, the SEC adopted several measures designed to increase the transparency of the rating agencies' rating methodologies, strengthen the rating agencies' disclosure of ratings performance, prohibit the rating agencies from engaging in certain practices that create conflicts of interest, and enhance the rating agencies' recordkeeping and reporting obligations to assist the SEC in performing its regulatory and oversight functions. We support these measures.Conclusion In the weeks since we released our plan for reform, we have been criticized by some for going too far and by some for not going far enough. These charges are stuck in a debate that presumes that regulation--and efficient and innovative markets--are at odds. In fact, the opposite is true. Markets rely on faith and trust. We must restore honesty and integrity to our financial system. These proposals maintain space for growth, innovation, and change, but require that regulation and oversight adapt as well. Markets require clear rules of the road. Consumers' confidence is based on the trust and fair dealing of financial institutions. Regulation must be consistent, comprehensive, and accountable. The President's plan lays a new foundation for financial regulation that will once again help to make our markets vital and strong. Thank you very much. FOMC20071206confcall--12 10,MS. KRIEGER.," Thank you, Nathan. I am going to review the terms of the auction. They were on page 17, in table 1, of the memo we circulated before the meeting. In particular, I will note some changes from the terms that we discussed in September. First, the TAF is proposed as a single-price auction. As previously proposed, in this single-price auction, all winners will pay the same fixed rate. The auction literature often touts single-price auctions as a format that encourages aggressive bidding by eliminating the so-called winner’s curse—that is, the possibility that the winner ends up paying more than would be necessary to win at the auction. This also should be welcomed by smaller institutions that may have less actual or perceived knowledge of market conditions. In practice, single- and multiple-price auctions each have their benefits. The single-price auction is operationally simpler, which is important given the limited time we have to prepare and execute an auction process. The term is approximately twenty-eight days, with some variation to facilitate auction scheduling. Spence Hilton will follow me in talking about this in the context of auctions that would take place around the upcoming holidays. The auction cycle is built around providing plenty of time for depository institutions to think about what to bid, for the Reserve Banks to take in bids, and for the auction agent to process bids and communicate results back to Reserve Banks for review. There is also a day for bidders to digest the results. So, the typical schedule is as follows: announce the auction details on Friday; hold the auction on Monday (or Tuesday, if Monday is a holiday); determine the winning bids on Tuesday and communicate these back to the Reserve Banks; announce the auction results to the public on Wednesday and Reserve Banks contact winning bidders in their Districts on Wednesday; and book winning bids as loans on Thursday. The minimum bid size that we propose is $10 million. In response to comments from this group in September, this was reduced from $50 million to be more accommodating of the desired bid sizes of smaller institutions. The maximum bid size is a total of 10 percent of the announced auction amount. The maximum bid size and the maximum award are the same for operational simplicity, and the maximum award was lowered to 10 percent in response to the preferences expressed by this group in September (from 20 percent previously). The maximum TAF is available to any single depository institution with adequate collateral. As I just said, any single depository institution can be awarded only 10 percent of the announced auction size. This will mean that, to cover an auction, as least ten depository institutions will receive funds. Also, bids will be constrained so that an institution’s term funding will not exceed 50 percent of its pledged collateral value. So, on the auction date, when the institution submits a bid, its outstanding TAF advances and any other term loans with maturity dates that extend beyond settlement date plus its TAF bids should not exceed 50 percent of the value of the institution’s margined collateral. This is to ensure that adequate collateral value is available to secure primary credit borrowing that may be necessary to cover unexpected funding needs. In the previous term sheet, the threshold was 80 percent. If the institution happens to have an overnight loan on the books on the day of the auction, the Reserve Bank typically would add back in the value of the pledged collateral in determining the margined collateral value unless it has reason to question whether this loan will be repaid on a timely basis. Eligible depository institutions are those eligible for primary credit—so those determined by the Reserve Bank to be in generally sound financial condition. These depository institutions also must have borrowing agreements and collateral in place. Reserve Banks have the flexibility to exclude particular institutions on a case-by-case basis in the event that the Reserve Bank has supervisory concerns that it feels are not adequately reflected in the eligibility criteria for primary credit. There is no prepayment, but each Reserve Bank has the discretion to terminate a loan as part of its risk-management procedures—that is, if it feels insecure. A minimum bid rate is established to set a floor for the auction stop-out rates. We are recommending that the overnight index swap rate—a measure of the expected average overnight fed funds rate over the coming month—be the minimum acceptable rate. This rate is made available on Bloomberg. The total amount auctioned is set in the context of the complete framework for managing reserve supply. The Chairman is responsible for setting the auction amount, upon recommendation of the SOMA Manager. A number of you had asked that we include an opportunity for noncompetitive bids to be submitted. While for the purposes of the first two auctions we wish to restrict bidding to competitive bidders, we hope to be able to accept noncompetitive tenders in subsequent auctions. Noncompetitive tenders would have a separate bidding window that preceded the window for competitive bidding. The amount could be up to $1 million. Bidders who submitted noncompetitive tenders would not be eligible to submit competitive tenders. Noncompetitive bids would be awarded at the stop-out rate for competitive bidding (that is, at the single price determined in the auction). Noncompetitive bids would be add-ons to the announced auction amount, to keep the other calculations straightforward for competitive bidders. The amount is not expected to be significant enough to be problematic for reserve management. Foreign branches of a single corporate entity would be treated as a single bidder. The bids of each branch would be submitted to the local Reserve Bank in accordance with the single-bidder guidelines, with the understanding that bids by multiple branches of the same FBO (foreign banking organization) would be aggregated by the auction agent and then again constrained to meet single-bidder guidelines. Thus only two rates may be submitted across the branches, and the amounts cannot exceed the 10 percent threshold. If the bids must be reduced to comply, they will be reduced proportionally across the relevant bidders. Similarly, the awards will flow back to the branches (through the local Reserve Banks) in proportion to the application of the auction results to the submitted bids. As noted in the paper we circulated last week, we did some preliminary analysis on the use of an automated front end to receive bids from depository institutions. We concluded at that time that automation was not cost effective or practical in view of the uncertainty around whether a TAF would be implemented and, if implemented, whether it would be used on a continued basis. It is sufficient to say that we recognize that this is an important enhancement if the TAF is to be used regularly. The Federal Reserve statistical release H.4.1 will record term auction funds as a line separate from “other loans to depository institutions,” the latter being the category under which primary, secondary, and seasonal credit is recorded. Thank you. I will turn now to Spence." CHRG-111hhrg58044--388 Mr. Pratt," Not really, because it is similar to asking us whether a creditor effectively uses a credit report for a lending decision. You have to have the creditor here in order to answer that question because they are the one that is going to be able to explain how they use the data, whether they include medical debts or do not include medical debts. I think that is very important. "